Certain potentially lucrative tax strategies exist under current tax law for Managed Service Organizations (MSOs). For MSOs structured as a flow-through entity, such as a partnership or S Corporation, noncorporate owners may be able to claim a 20% Qualified Business Income (QBI) deduction. For MSOs structured as a C corporation, noncorporate shareholders may be able to exclude up to 100% of gain on the ultimate sale of stock in the corporation.
Intrigued?
Before delving into more detail, let us provide you with some general information about MSOs.
What is an MSO?
An MSO is a structure used in healthcare to separate the nonclinical from clinical activities. MSO services can include management and administrative services such as billing, human resources, compliance, IT support, and other nonclinical operations. It typically employs all non-clinical staff. The MSO services generally support a related healthcare practice.
Creating an MSO structure is sometimes used as a way for non-physician founders to start a healthcare company, having their ownership stake in the MSO, while the company providing the clinical services must be owned exclusively by licensed physicians to practice medicine in a specific state.
MSOs can use structures such as joint ventures or partnerships to raise investment for various needs, such as expansion and medical equipment purchases. However, they must be careful to function within guidelines, known as Corporate-practice-of medicine (CPOM) rules. These rules exist in various states, including New Jersey, to prohibit non-physicians from owning medical practices. The primary goal of these laws is to ensure that medical decisions are made solely based on medical care and not influenced by corporate interests.
MSO Guidelines
One such compliance requirement is the arm’s-length pricing of services provided by an MSO to a healthcare organization. Essentially, the healthcare organization that engages the MSO for services must pay arm’s-length prices, i.e. prices consistent with what independent parties would agree to pay in similar circumstances. This requires comprehensive analysis including an understanding of services, comparable transactions and market rates. An MSA, or Management Services Agreement, is a contract between the entity providing clinical services and an MSO that outlines the services to be provided, how payment is structured and how both parties will maintain compliance with CPOM laws.
The owner of the clinical practice entity is often referred to as a “friendly physician.” Their responsibilities include providing medical oversight and consultation to healthcare businesses and they help to ensure compliance with state CPOM laws and regulations. The term “friendly” typically refers to their collaborative relationship with the MSO.
The selection of an entity structure for an MSO can vary from flow-through entities to corporate structures. Both legal and tax matters should be considered when selecting an entity type. Among the tax considerations, there are currently some distinct advantages to each entity type including the QBI deduction and the Sec. 1202 gain exclusion.
Potential Tax Implications
For a flow-through entity to claim a QBI deduction, certain criteria must be met. Specified service trades or businesses (SSTBs), including but not limited to businesses in the fields of health, law and accounting, have even more stringent requirements to meet for purposes of the QBI deduction. Also, if one trade or business provides services to a trade or business that is an SSTB, then the portion of the trade or business entity providing property or services to the SSTB is also considered a separate SSTB if there is a 50% or more common ownership between the two businesses. With proper structuring, however, an MSO would not be providing specified services and would avoid characterization as an SSTB. The MSO may be able to maximize its non-SSTB income and, in turn, maximize the QBI deduction for its owners. Thus, an MSO would be more apt to benefit from the QBI deduction than would a medical practice.
For a C corporation’s noncorporate shareholders planning for ultimate gain exclusion under IRC Sec 1202 on the sale of their shares, the shares must be held more than five years. For its stock to be eligible for Sec 1202 gain exclusion, an MSO must be a C Corporation, and its shares must be issued to the noncorporate shareholder at original issuance. The corporation’s aggregate gross assets must not exceed $50 million on or after Aug. 10, 1993, and before and immediately after stock issuance. The corporation must use at least 80% of its assets in the active conduct of one or more qualified trades or businesses. The gain for a tax year eligible for exclusion is capped at $10 million or 10 times the shareholders’ adjusted basis in the stock, whichever is greater.
If MSOs are planning to accumulate their earnings in the C Corporations, the MSO may also have an added advantage of the lower corporate tax rate as compared to individual tax rate at which earnings of a flow-through entity may be taxed. The MSO should be wary of Accumulated Earnings Tax in the case of earnings retention demed over and above what is required for business purposes and cash needs and plan appropriately.
It’s apparent that forming an MSO can result in both operating and tax efficiencies. Before implementing any such strategy, be sure to consult your tax adviser as some of these provisions, unless extended, may expire for tax years beginning after December 31, 2025.
Contributed by Terri L. Marakos, CPA, CHBC
Article Sources:
- From the May 2025 Tax Adviser p. 34 Tax planning for health care management services organizations
- https://www.permithealth.com/post/the-friendly-pc-mso-model-for-corporate-practice-of-medicine-compliance
- https://www.healthcareperspectivesblog.com/2022/07/the-prohibition-on-the-corporate-practice-of-medicine-is-alive-and-well-in-new-jersey/
