Tax planning for health care management services organizations

Editor: Jeffrey N. Bilsky, CPA

In the rapidly evolving health care industry, organizational structures often include management services organizations (MSOs) to set apart clinical and nonclinical activities. The purpose of an MSO is to support the related health care practice by providing essential administrative and management services. MSO services can include billing, human resources, compliance, IT support, and other nonclinical operations.

Considering the regulations and tax regimes applicable to MSOs allows organizations to select the most tax–effective arrangement for their specific circumstances.

Corporate-practice-of-medicine doctrine

An MSO structure can create operational efficiencies and cost savings, but it also must adhere to various state corporate–practice–of–medicine (CPOM) rules, which generally prohibit nonphysicians (including entities) from owning medical practices.

The CPOM doctrine presents unique challenges for MSOs, particularly with respect to structuring capital raises. CPOM rules are designed to prevent nonphysicians from influencing medical decisions, thus protecting the integrity of patient care. To comply with CPOM regulations while attracting investment, MSOs may explore various strategies such as forming joint ventures or strategic partnerships. These structures can provide the medical practice access to necessary capital for expansion, medical equipment purchases, and other technological investment without violating CPOM rules, ensuring both compliance and financial growth.

Services at arm’s length

When health care organizations operate within an MSO structure, the organization compensates the MSO for services performed for the clinical entities. Services must be performed at “arm’s length” — the pricing of services should be consistent with what independent parties would agree upon in similar circumstances. Benchmarking these cross–charges involves analyzing comparable transactions in the market to determine a fair price for the services provided. This process requires a thorough understanding of the services offered, the value they add to the clinical business, and prevailing market rates.

By adhering to arm’s–length principles and conducting rigorous benchmarking, MSOs can ensure compliance with tax and other regulations as well as optimize their tax positions.

MSO tax planning strategies

Depending on the size and enterprise value of the organization, options exist to structure the business from a tax perspective, with various tax planning strategies to consider. If the MSO operates as a passthrough entity (either as an S corporation or a partnership), the owners of the business may be entitled to claim the 20% qualified business income (QBI) deduction pursuant to Sec. 199A. For qualifying MSOs that operate as C corporations, the benefits afforded qualified small business stock (QSBS) may be available for the shareholders upon exit.

Sec. 199A QBI deduction: The QBI deduction under Sec. 199A is a potential tax planning opportunity for MSOs structured as passthrough entities. Enacted as part of the Tax Cuts and Jobs Act (TCJA), P.L. 115–97, Sec. 199A allows noncorporate owners of eligible passthrough entities to claim a deduction of up to 20% of their share of the passthrough entity’s QBI.

For its income to qualify as QBI under Sec. 199A, an MSO must meet specific criteria outlined in the Code. Further, the deduction is subject to limitations based on the taxpayer’s taxable income, the type of trade or business, the amount of W–2 wages paid by the business, and the unadjusted basis immediately after acquisition (UBIA) of qualified property.

Sec. 199A deductions for QBI of specified service trades or businesses (SSTBs), which include, but are not limited to, businesses in the fields of health, law, and accounting, are phased out for taxpayers with income above a certain threshold. In addition, if one trade or business provides services to a trade or business that is an SSTB, then the portion of the first trade or business entity providing property or services to the SSTB is also considered a separate SSTB if there is 50% or more common ownership between the two businesses (i.e., the businesses are related parties under Sec. 267(b) or 707(b)).

The establishment of a “friendly physician” to hold legal title to the physician practice as required under CPOM rules may allow the MSO to avoid SSTB status. MSO structures generally isolate nonclinical activities from the clinical business that performs health care—type services. MSOs using a passthrough entity structure thus may be able to maximize their non–SSTB income and, in turn, maximize QBI tax deductions for their owners before applying other limitations (i.e., wage and/or UBIA thresholds).

The Sec. 199A deduction may be limited to the greater of 50% of W–2 wages or 25% of W–2 wages plus 2.5% of the UBIA of qualified property. However, for owners of SSTBs, additional limitations apply based on the deducting taxpayer’s taxable income, which for the 2025 tax year is $394,600 for joint filers and $197,300 for other filers. Additional considerations include aggregation rules, loss carryovers, and the exclusion of investment income and employee wages from QBI.

Note that the QBI deduction was a temporary provision included in the TCJA and is set to expire at the end of 2025. Therefore, unless extended or made permanent, Sec. 199A will not apply to tax years beginning after Dec. 31, 2025.

Sec. 1202 gain exclusion: Sec. 1202 may provide a valuable tax planning strategy for MSOs structured as C corporations. This provision allows noncorporate taxpayers to exclude gain from the sale of QSBS held for more than five years. The exclusion can be up to 100% of the gain, subject to certain limitations.

For its stock to qualify as QSBS eligible for the Sec. 1202 exclusion, an MSO must meet several criteria, including:

• The MSO must be a C corporation, and its stock must be issued to a noncorporate taxpayer at original issuance;
• The corporation’s aggregate gross assets (the amount of cash and the adjusted bases of other property held by the corporation) must not exceed $50 million at all times on or after Aug. 10, 1993, and before the stock issuance and immediately after the issuance; and
• The corporation must use at least 80% of its assets, measured by value, in the active conduct of one or more qualified trades or businesses.

By meeting these requirements, shareholders may be able to achieve substantial tax savings upon the sale of their corporate MSO stock. Sec. 1202(b) caps the amount of gain for a tax year eligible for exclusion at $10 million (less eligible gain excluded under Sec. 1202 in previous years attributable to dispositions of stock issued by the corporation) or 10 times the taxpayer’s adjusted basis of the QSBS issued by the corporation and disposed of by the taxpayer during the tax year, whichever is greater. The exclusion may also be limited to a certain percentage based on the date of the original issuance. However, gain on QSBS acquired after Sept. 27, 2010, and held for more than five years can qualify for a full exclusion.

An additional potential advantage of the QSBS regime, in which the MSO is structured as a C corporation rather than a passthrough entity, is the currently lower federal income tax rate applicable to C corporations. If the business objective is to accumulate the corporation’s earnings instead of distributing them to shareholders, the corporation will be subject to a single level of tax at the lower federal income tax rate, which is currently 21%. However, the IRS can challenge the retention of earnings under the rules for the accumulated earnings tax (AET). While an extensive discussion of the AET is beyond the scope of this item, to reduce the risk of AET being imposed, the corporation must document that the earnings have been retained pursuant to a business purpose and corporate cash need.

The current 21% federal corporate income tax rate is in contrast to the highest individual marginal tax rate of 37%, or 29.6% when considering the QBI deduction. (Note that the highest individual marginal tax rate of 37% was a temporary provision included in the TCJA. Unless the rate reduction is extended or made permanent, the highest individual marginal tax rate will revert to 39.6% in 2026.)

Planning for efficiencies

When structuring a health care organization for tax purposes, it is important to consider various factors that align with the appropriate planning strategies for the specific situation. MSOs offer strategic advantages in the health care industry by enhancing operational efficiency and compliance. Through proactive tax planning that includes understanding and leveraging available tax planning opportunities, health care providers, MSOs, and their owners can improve their tax and financial outcomes, helping them to continue to thrive in a competitive and regulated environment.

Editor Notes

Jeffrey N. Bilsky, CPA, is managing principal, National Tax Office, with BDO USA LLP in Atlanta.

For additional information about these items, contact Bilsky at jbilsky@bdo.com.

Contributors are members of or associated with BDO USA LLP.