If you are a private equity (PE) firm that invests in physician practice management companies, it is a common question: What constitutes control, and how much is too much? This is a question that commonly has been asked under state law corporate practice of medicine prohibitions. On the flip side, control, and having enough of it, is paramount to being able to consolidate managed physician practices for GAAP financial reporting purposes and federal income tax purposes. For 2024 and beyond, layer onto that the complexities of complying with the Corporate Transparency Act (CTA), and you just may have a riddle wrapped in a mystery inside an enigma.
Under the CTA, a company is required to report information about its beneficial owners to the Financial Crimes Enforcement Network (FinCEN) through the submission of a Beneficial Owner Information Report (BOI Report) unless it qualifies for an exemption. The most common exemptions available to PE-backed portfolio companies are the large operating company and subsidiary exemptions.
The large operating company exemption will apply to a company that employs more than 20 persons on a full-time basis, generates more than $5 million of annual revenue from U.S. operations, and has an operating presence at a physical office in the United States. Although a management services organization (MSO) for a large, established physician practice management company may be able to meet this requirement at the closing of a transaction, the same may not be true for a newly formed MSO entity, as the $5 million revenue target will not be measured until the MSO entity files its first tax return. In addition, even large affiliated physician practices managed by the MSO that have $5 million in revenue may not meet the large operating company exemption as many MSO models employ only providers at the practice level and shift all non-provider and administrative employees to the MSO, often resulting in the practice entity falling short of the more than 20 employees requirement necessary to meet the exemption. Of note, leased employees do not count towards the requirement of more than 20 employees.
The CTA also provides that subsidiaries of certain exempt entities (including large operating companies) are exempt from the CTA reporting requirements. In order to qualify for the subsidiary exemption, the ownership interests of the entity at issue must be controlled or wholly owned, directly or indirectly, by an exempt entity (including certain qualifying PE firms). Recent FinCEN guidance has clarified that in order to establish the requisite control to claim the subsidiary exemption, the up-the-chain or affiliated exempt entity must “entirely control” all of the ownership interests in the entity at issue in the same way that an exempt entity must wholly own all of a subsidiary’s ownership interests or control a portion of a company’s equity ownership combined with ownership of the balance of a company’s equity ownership.
Although this exemption may be available for MSOs that employ the parent company MSO model in which a qualifying PE firm controls the MSO company, it may pose challenges to firms that employ the local MSO joint venture (JV) model. Further, absent further guidance from FinCEN, restrictions imposed by the prohibition on the corporate practice of medicine that persist in a majority of states may present challenges to PE firms trying to meet the exemption for the affiliated physician practices managed by their MSOs. These restrictions arguably prohibit the PE-backed MSO from having “entire control” over the practice and, at a minimum, require that clinical decision-making and clinical control be reserved to the legal physician owners of the practice. This can be distinguished from the requirement for consolidating managed physician practices for GAAP financial reporting purposes, which turns on the consolidating entity having a “controlling financial interest” in the form of majority ownership or both (1) the power to direct the activities of the entity that most significantly affect the entity’s economic performance and (2) the obligation to absorb losses of — or the right to receive benefits from — the entity that could potentially be significant to the entity. Likewise, a distinction can be drawn between the “entire control” requirement under the CTA and the control requirement for consolidating affiliated managed physician practices for federal income tax purposes, which requires that the consolidating entity have significant incidents of ownership amounting to “beneficial ownership” of the affiliated managed physician practice, as that term is defined in IRS private letter rulings and judicial precedent.
As a reminder, companies formed in 2024 that do not qualify for an exemption are required to file a BOI Report within 90 days of formation. Entities that were in existence prior to January 1, 2024, that do not qualify for an exemption are required to report to FinCEN no later than January 1, 2025.
Given the foregoing, every PE-backed MSO and its affiliated physician practices should be analyzed through the above lens. PE firms will have several layers of analysis to undertake as they evaluate their portfolio companies in the physician practice management space. We will continue to monitor the rapidly evolving guidance under the CTA. If you have any questions, please contact either the authors or your contact person on the Bass, Berry & Sims Healthcare PE Team.