Tax considerations in health care deals

ARTICLE | April 30, 2024

Authored by RSM US LLP

Tax structuring and tax due diligence are critical aspects of any deal. However, health care deals present distinct challenges, as the industry is subject to specific federal and state regulations. Thorough examination of all tax-related considerations before finalizing a health care transaction is critical to mitigate risk and obtain anticipated deal value.

This article explores six notable tax considerations in health care deals.

1. Tax structuring: “Friendly doctor” and other considerations

The basic premise of tax structuring applies to health care deals. Buyers tend to prefer asset or deemed asset transactions, which provide a stepped-up tax basis in the acquired assets equal to the fair market value, producing a tax shield. Sellers, on the other hand, tend to prefer selling equity with no tax step-up, to limit future liability, increase administrative ease and secure capital gains tax treatment.

That said, health care structures need to also consider state regulations and the types of entities a state will allow (e.g., corporation, partnership, etc.); who is allowed to be an owner in a regulated health care company (e.g., licensed individuals, a certain percentage of licensed individuals, etc.); and what economic arrangements are permitted.

For example, in a “friendly doctor” structure, many states have laws against the corporate practice of medicine and require a licensed physician to own the practice entity. As a result, a nonlicensed buyer may need to set up a separate entity—namely, a management services organization (MSO)—to purchase the nonclinical assets of the practice and enter into a management services agreement with the practice entity.

The agreements between practice entities and the MSO affect how the IRS views the structure and the tax reporting implications going forward. Regardless of the type of health care transaction, effective tax structuring is critical for tax efficiency and shaping the overall economics of the deal.

2. Transfer pricing: Reviewing and structuring for compliance and tax efficiencies

Transfer pricing considerations assume particular significance in health care deals, as organizations often engage in transactions with related parties, such as the transfer of intellectual property, services or products. The complexity of the health care industry, with its diverse revenue streams and specialized services, necessitates careful consideration of transfer pricing implications in transactions.

Ensuring that transactions between related parties are conducted at arm’s length is crucial for compliance with tax regulations. Addressing the transfer of services, goods, intangible assets and internally developed software as well as service arrangements, cost-sharing agreements, cross-border transactions and advance pricing agreements (APAs) is vital for preventing tax liabilities and aligning with regulatory expectations.

Reviewing and structuring for transfer pricing during a transaction not only facilitates regulatory compliance but also helps in optimizing tax efficiencies and avoiding potential disputes with tax authorities post-close.

3. Accounting methods: Revenue recognition and more

Accounting methods are another key area to assess in health care deals. The impact of tax accounting methods on a transaction may be significant, influencing both the valuation and the ongoing tax liabilities of the target.

The cash method of accounting and revenue recognition are common tax issues in health care deals; understanding differences among financial and tax methods is key. Many sellers on the cash method need to convert to accrual, while buyers typically want to be shielded from any additional taxes on the switch from cash to accrual.

Additionally, revenue and expense recognition can be complex and affect the perceived value of the target. Moreover, disparities in tax accounting methods may lead to differing taxable income calculations pre- and post-transaction.

A buyer must assess the compatibility of the target’s tax accounting methods with its own, considering any necessary adjustments to maximize overall tax efficiency. A thorough review of the tax accounting methods is important for identifying and addressing potential discrepancies, minimizing surprises and optimizing the financial outcome of the transaction.

4. Sales tax: Exemption certificates and understanding nexus

Sales tax issues can be difficult to address in health care deals because variations in sales tax regulations and rates across jurisdictions complicate the analysis.

Sales tax considerations extend beyond the traditional sale of goods, encompassing a diverse range of services, both in-person and telehealth; the transfer of tangible personal property; the sale or lease of durable medical equipment; and the use of medical supplies. Successfully managing the taxability of services, tangible personal property and contractual obligations—including intercompany service arrangements—requires a meticulous approach.

Equally important are the proper handling of exemption certificates, understanding nexus and ensuring accurate sales tax reporting. Reviewing sales tax filings and processes is essential for identifying potential liabilities related to past sales tax filings and ensuring compliance with local tax laws. Addressing these issues proactively can mitigate risks, contribute to a successful transaction outcome and streamline the integration process.

5. Unclaimed property: Beyond the conventional scope

Unclaimed property considerations in health care deals extend beyond the conventional scope, encompassing a broad range of financial transactions. The three most common property types are:

  • Uncashed payroll checks
  • Uncashed accounts payable/vendor checks
  • Accounts receivable credit balances, including those that historically have been written off

Health care providers also commonly have issues with patient refunds, deposits, insurance payments and reimbursements, trust fund accounts, and medical equipment deposits.

Patient credit balances may arise due to duplicate payments and overpayments resulting from complicated payment application processes, particularly when multiple payors are involved, and a lack of accurate adherence to contractual agreements with insurers.

The complexities of health care payments present account reconciliation issues that examiners often target because the burden of proof that funds are not due is on the holder of the funds. In some cases, even the rightful owner is unclear as to whether the funds belong to the patient or an insurer.

Other considerations are contractual estimates versus true credits, state and federal insurance recoupment laws, and business-to-business exemptions. Failing to address these issues adequately can result in penalties and financial repercussions. Proper due diligence in uncovering and resolving unclaimed property matters contributes to regulatory compliance and risk mitigation.

6.  Payroll tax: Identifying and remediating discrepancies

The complex nature of health care organizations, with diverse employee classifications and compensation structures, necessitates a thorough examination of the payroll tax compliance filings and processes. This includes properly classifying health care professionals and administrative staff as employees or independent contractors to ensure accurate tax withholdings and proper treatment under applicable regulations.

Reviewing compliance with federal and state payroll tax regulations is critical to identifying and remediating discrepancies. Unemployment taxes, fringe benefits, employee expense reimbursement, and owner personal expenses should also be reviewed. By conducting a thorough examination of payroll tax matters during a transaction, potential exposures can be identified and addressed pre-close, in the purchase agreement, or post-close.

The takeaway

Tax structuring and tax due diligence play a vital role in the success of a health care deal. The health care industry has an intricate regulatory landscape, with tax issues specific to health care transactions. To help ensure a successful transaction, buyers and sellers should seek support from advisors familiar with the industry and its complexities.

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This article was written by Sara Neff and originally appeared on 2024-04-30.
2022 RSM US LLP. All rights reserved.

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

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