Key Considerations: Management Services Organization Tax and Fee Structures
A version of this article was published in the March 2023 edition of Healthcare News.
The management services organization (MSO) structure has gained prominence in the health care sector, driven by ongoing M&A activity in digital health and provider groups. As health care organizations increasingly seek to expand their service offerings, MSOs play a critical role in enabling nonphysicians to have legal ownership while navigating complex regulatory environments.
When a company operates across multiple states through contracting, employing providers, and maintaining a physical presence, compliance can become intricate and challenging. Understanding the nuances of MSO and professional corporation (PC) structures is essential for health care organizations to effectively manage these complexities and capitalize on growth opportunities.
What Is a Management Services Organization Structure?
The MSO structure is increasingly common among private equity or venture capital firms, which can invest in the MSO but can’t directly own the PC, which is wholly owned by one or more licensed clinicians. Companies with a multistate presence may have multiple PC entities in their organizational structure.
Typically, the professional fees are billed and collected by the PC that employs the providers and pays management fees to the MSO in exchange for administrative, management, and technology services. The economics of the intercompany agreement will often result in the corporation having no net income, or an overall net loss for a start-up or expanding business.
Regulatory and corporate practice of medicine laws specific to each state can vary significantly and may impose restrictions on the management fee and intercompany agreements. If the management services agreement is silent on pricing, that could create issues under a state taxing authority exam.
How the MSO fee structure is determined can vary greatly, but there should be support and consideration of fair market value and a regular cadence for payment.
IRS Rule on Consolidation for Income Tax Filings
The IRS clarified this rule in 2020, but tax advisors are finding that many companies with an MSO structure haven’t yet considered whether they would benefit from a consolidation of their income tax return filings.
Generally, two or more corporations can consolidate income tax returns only if they meet the 80% common ownership test or have a parent subsidiary ownership structure. There are two private letter rulings (PLR) issued by the IRS, PLR 201451009 and PLR 202049002, that highlight the IRS’s position on arrangements between MSOs and PCs for consolidated tax filings.
Consolidation could be done if the MSO and PC contractual arrangements provide for beneficial ownership by effectively transferring sufficient attributes of control and economics to the MSO entity, so that the IRS would conclude that the MSO entity is the beneficial owner of the PC for purposes of the consolidated tax filings.
Consolidation of Corporate State Income Tax Filings
If beneficial ownership is determined between the MSO and PC, the company may file consolidated for federal income tax purposes. If the MSO and PC are a unitary business for state income tax purposes, then certain states could allow or require combined reporting.
A unitary business would typically have a similar ownership structure—such as, common control of more than 50% of the ownership interest—and business activities that result in a flow of value between businesses, like centralized management or functional integration.
Consolidating a Management Services Organization and Professional Corporation Structure
Organizations should be aware of the following considerations when determining whether to file on a consolidated or combined basis:
- Not all states allow combined or consolidated filing for income tax purposes. States that have adopted unitary combined reporting require a unitary business analysis to determine eligibility.
- Consolidated reporting for federal income tax purposes is only available for C corporation taxpayers. An MSO-PC structure can only pursue consolidated income tax reporting if both entities are C corps; this option is not available if the MSO is taxed as a partnership.
- Separate accounting records are necessary. Consolidation for income tax reporting does not eliminate the requirement to maintain accounting records for each legal entity. Companies must continue to account for revenues and expenses attributable to each separate entity.
Benefits of a Management Services Organization and Professional Corporation Structure
The benefits of combined or consolidated reporting for income taxes, if available, include:
- Fewer federal and separate state income tax returns to be filed, which helps reduce errors
- The ability to consolidate net operating losses
- Fewer separate payments for minimum income tax and franchise taxes
- Fewer state income tax accounts to manage
- Possible elimination of some equity or receipts subject to net-worth or gross-receipts taxes in certain states
State Tax Considerations
State tax considerations are critical for MSO-PC structures and can significantly impact the overall cost of doing business for digital health and provider groups. Among these considerations, the consolidated filing position is just one of many factors to evaluate. Key state tax issues include:
- State income, sales, and gross receipts taxes, including nexus considerations that determine tax obligations based on business presence, and the taxability of intercompany transactions.
- Taxability of services and software-as-a-service (SaaS), which involves understanding the implications of separate versus bundled charges.
- Payroll tax compliance, ensuring that contracted physicians are accurately classified as either employees or independent contractors.
Understanding these state tax considerations is essential for MSOs and PCs to mitigate risks and ensure compliance in a complex regulatory environment.
We’re Here to Help
For guidance on whether an MSO-PC structure is right for your organization, or if you have further questions on accounting for this type of structure, contact your Moss Adams professional.