The IRS recently issued a private letter ruling which allowed a for-profit medical group (e.g., a hospital) to benefit from losses sustained by its wholly owned physician medical group – and allowed this to occur in a state that generally bans the corporate practice of medicine.
The practice of medicine is generally carried on by licensed physicians, often times through a professional corporation (PC) which is wholly owned by the very same licensed physicians who are practicing medicine. In some states (e.g., California, Colorado and Texas) this structure is required because applicable state law prohibits non-physicians from owning equity in the PC. These state law prohibitions impose a ban on the corporate practice of medicine, except in limited situations.
The ban on the corporate practice of medicine is problematic for those “for-profit” groups – hospitals and healthcare management companies alike – who are in the business of acquiring physician practices. To overcome the ban on the corporate practice of medicine, the for-profit group, essentially acting as an acquirer, and the PC, essentially acting as a target, enter into several complex multi-faceted contractual arrangements to accomplish the desired goals. Specifically, the licensed physicians remain the sole equity owners of the PC, as required by state law. However, the for-profit group performs all the administrative services generally required of the PC (e.g., payroll, IT support, billing, etc.) in consideration for a fee, the amount of which essentially strips the PC of all its profits. As a result, the for-profit hospital is able to achieve the desired economic arrangement, while at the same time complying with state law. And, in an effort to preserve the arrangement, the parties enter into additional stock transfer agreements which prohibit the transfer of PC stock without the for-profit group’s consent and approval.
While this arrangement accomplished almost everyone’s business goals, it failed to capture a critical economic element. Specifically, if the PC generated losses – which were typical in the early years following the deal with the for-profit group – then those losses would be “trapped” within the PC as owned by the licensed physicians. And the for-profit hospital group, which funded those losses, was unable to use those losses to offset income from the for-profit group’s other endeavors.
The IRS recently published PLR 201451009 concluding that a for-profit group could benefit from the PC’s losses. The PLR ruled that, even though the licensed physicians owned the PC’s shares, based on all the other facts and circumstances the for-profit hospital was permitted to include the PC as a member of the for-profit’s consolidated group. As a result of such inclusion, the PC’s losses would be reported on the for-profit group’s consolidated return and could offset income from the for-profit group’s other endeavors.
This ruling is welcome news for (i) physician-owned PCs and PLLCs who either have been acquired or are looking to be acquired by for-profit groups, and (ii) for-profit groups who have previously acquired or are looking to acquire physician owned PCs and PLLCs. Parties meeting any of those descriptions should consult with both their tax attorney and health law attorney to see if they can restructure their arrangement similar to what was described in the private letter ruling. If they are able to do so, then the for-profit group may be able to take advantage of losses which were previously believed to be unavailable to it.
