On December 4, 2020, the IRS released a new private ruling (PLR 202049002), holding that a physician-owned medical services professional corporation (PC) could be included in a consolidated tax return filing along with the PC’s management service organization and related corporations. This most recent letter ruling may be useful for telemedicine companies and other multistate medical services providers, as they consider federal tax matters.
Prohibition on the Corporate Practice of Medicine
One of the legal hurdles associated with building a multi-state medical services provider is the prohibition on the corporate practice of medicine (CPOM). CPOM laws generally prohibit an entity from delivering medical services or employing physicians if the entity is owned by lay persons (i.e., non-physicians). This presents a challenge for health care service companies seeking investments from private equity, venture capital, or similar sources that are generally only willing to invest in exchange for an ownership interest. CPOM laws exist in approximately 25 states, rendering this legal barrier to entry particularly noteworthy for multistate tech-enabled health care services companies, such as many telemedicine and digital health entrepreneurs.
Due to state CPOM restrictions that prevent a layperson or business corporation to practice medicine, arrangements involving lay investors sometimes use a structure where an investor-owned management services organization (MSO) provides management, technology, and administrative services to an affiliated professional corporation (PC). The PC is not owned by the MSO; it is wholly-owned by one or more licensed clinicians. The PC compensates the MSO for its non-clinical administrative services by paying a management fee. The affiliation between the MSO and the PC is achieved through a hand-in-hand close working relationship, as well as a series of contractual agreements, the MSO’s provision of management services and technology, and sometimes start-up financing for the PC. The laws and restrictions of each particular state’s CPOM prohibition typically inform the nature of such contractual arrangements.
At its most basic, the overall arrangement is intended to allow the MSO to handle the non-clinical aspects of the PC’s operations without infringing on the professional medical decision-making and practice of medicine wholly reserved to the PC, its owners, or its clinicians.
IRS Rules on Consolidated Tax Filings for PC-MSO Structures
Under IRS rules, a group of two or more corporations can file tax returns on a consolidated basis only if at least 80% of the outstanding stock of each corporation in the group—other than a “parent” corporation—is owned by the parent or other group members or a combination thereof. Prior to this recent ruling, the IRS addressed affiliated PC-MSO arrangements in 2014 (PLR 201451009). In that ruling, the IRS explained that, for purposes of the 80% test, simple legal ownership or “title” is not determinative. Rather, the test is determined by beneficial ownership: who has effective control of a corporation and who has and bears the economic benefits and burdens of corporate ownership. In the 2014 ruling, the IRS found the suite of contractual arrangements between the PC and the MSO effectively transferred sufficient attributes of control and economics to the MSO, so that the IRS concluded the MSO was the beneficial owner of the PC for purposes of consolidated tax filings.
The 2020 letter ruling is consistent with the 2014 IRS ruling. In the arrangement at issue, all the outstanding stock of the PC was, as required by applicable state law, owned by a licensed clinician, and not any group member of the corporation. The MSO provided a broad suite of management services to the affiliated PC. The applicant further represented that:
- the PC has never declared nor paid any dividends, nor made other distributions, to any shareholder;
- the PC does not intend to declare or pay any dividends or make any other distributions, to any shareholder, except for payments to the MSO and that the MSO intends to prevent the PC from paying any dividends or making any other distributions to any shareholder;
- in the event ownership of the PC is transferred to another clinical owner pursuant to the agreement containing protective transfer provisions, such designated transferee will be required to execute a new agreement having protective transfer terms substantially similar to the existing agreement;
- the legal arrangements created by the protective transfer provisions are valid and legally enforceable under applicable law;
- applicable law prohibits only legal, and not beneficial, ownership of stock in PC by MSO; and
- PC is not a tax-exempt corporation, an insurance company subject to tax under section 801 of the Code, a foreign corporation, a regulated investment company, a real investment trust, a domestic international sales corporation, or an S-corporation.
In issuing its ruling, the IRS relied upon the applicant’s representations and did not independently verify or validate their accuracy. The IRS ruled the PC could be treated as a member of the affiliated group (within the meaning of Sec. 1504(a)(1) of the Internal Revenue Code) and would be permitted to join in the filing of a consolidated federal income tax return with the parent group.
The ruling is binding only between the IRS and the applicant taxpayer requesting the ruling, but may be informative in analogous tax situations. For example, this most recent letter ruling may be worth examining by telemedicine companies and other multistate medical services companies using a PC-MSO structure who desire to consolidate the operations of the PC with the management services company for tax purposes and allow losses of the PC to offset income of other members of the affiliated group.
We will continue to monitor for any rule changes or guidance on federal tax consolidation and the telemedicine industry.