The MSO-PC model, also known as the “Friendly PC model,” has been gaining popularity in recent years as the digital health, telehealth, and healthtech industry in general has been exploding in the post-COVID era. This model has been essential to growing virtual health businesses that need to remain in compliance with the Corporate Practice of Medicine (CPOM) laws; however, there are several legal and tax considerations to be aware of when considering whether to file a consolidated federal income tax return for the entities within the structure. The typical benefit of filing a consolidated federal income tax return is that it allows losses of one entity to offset income in another entity. This cannot be done if the entities file separately.
Generally, to file a consolidated federal income tax return under section 1504 of the Internal Revenue Code, an affiliated group of corporations must share direct ownership from a common parent of at least 80% of the total voting power and total value of the stock of the includible corporations. This rule is typically at odds with the MSO-PC structure, given that the MSO-PC structure and CPOM laws require that a licensed professional own the PC while the MSO is usually owned by a separate group of investors.
That being said, the IRS has issued several taxpayer-friendly private letter rulings (PLRs) on this topic over the years. In the rulings, the IRS has allowed the filing of consolidated tax returns even though the MSOs did not own legal title to any stock in the PCs. The IRS concluded that the MSO held beneficial (as opposed to legal) ownership of the PC stock, which could count under the 80% ownership requirement of section 1504. Based upon the guidance provided in these PLRs, the analysis turns on whether the MSOs have effective control of the PCs and whether they bear the economic benefits and burdens of ownership of the PCs.
The PLRs lay out a blueprint for how to structure the MSO-PC agreements in a way that satisfies the beneficial ownership tests, but it is not always beneficial to file consolidated income tax returns. For example, states may not follow the federal treatment. There are several states that prohibit the filing of a combined or consolidated return; therefore, the importance of appropriate intercompany charges would still be relevant despite a consolidated filing.
Another reason relates to gain exclusion for qualified small business stock under section 1202. If an MSO operates a qualified business for purposes of section 1202, then consolidating with one or more PCs could cause problems because the practice of medicine is not a qualified business for purposes of section 1202.
The determination of tax ownership is complex, and taxpayers need to analyze their specific facts carefully before they decide to file a consolidated federal income tax return. PLRs provide certainty to the parties that requested it, but they are not precedential for other taxpayers, and other taxpayers cannot cite PLRs as binding authority in a court of law. Reliance on a PLR also raises concerns for positions taken in financial statements, including with regard to reserves and uncertain tax position reporting.
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For more information on this topic, please contact a member of Withum’s Digital Health Services Team.
