Management Services Organizations (MSO) have been common in the medical space for many years, existing to assist and streamline administrative, back office, and other non-clinical services for physician practices. MSOs can provide value by assisting practices in achieving economies of scale, relieving administrative burdens of running practices, and acting as a de-facto method of accessing capital for practice expansion. For many years, the benefits of MSOs were often only realized by larger practices and hospitals who had complex back office requirements and systems. However, after the passage of the Tax Cuts and Jobs Act in 2017 (TCJA), there has been a renewed interest in MSOs for small and mid-size practices as a method of providing potential tax benefits.
Services of an MSO
While many physicians are familiar with MSOs and their role in reducing administrative burdens, there can often be misconceptions as to what services an MSO can typically (or legally) provide. Understanding the types and nature of the services provided will be crucial to their potential benefits under the TCJA. The most common services include:
- General Administrative Services
- Personnel Administration & Benefits Management
- Fiscal Services
- Management Reporting
- Managed Care Negotiation and Contracting
- Physician Compensation Administration
- Marketing and Advertising
- Records Management
- Strategic Analysis
- Access to Capital
- Facilities and Equipment
These services are provided for a fixed and determinable management fee, designed to compensate the MSO at a Fair Market Value for the services provided. From a clinical perspective, outsourcing of these services allows the providers to focus the majority of their time on patient care, often resulting in higher patient satisfaction and potential net increases in the bottom line, by taking the time saved and providing additional services.
Potential Tax Benefits under the Tax Cuts and Jobs Act
As part of the 2017 Tax Reform, a provision was passed allowing an additional 20% deduction for Qualified Business Income of a pass-through entity. This can be referred to as the Section 199A deduction or Qualified Business Income deduction. However, specified service industries (as listed in Section 1202) were excluded from taking advantage of these provisions, among which Healthcare was specifically stated. This left many small and mid-size health care practices in the position of not seeing any benefits from the passage of the TCJA.
One possible solution many practices have been exploring has been the formation of a separate MSO entity to provide the above services to their practices. At this time, unfortunately, much uncertainty still exists as to the viability of this strategy. To start, the same Section 1202 that excludes services in health also excludes “consulting” or any business where the “principal asset” is the skill or reputation of the employees. There is uncertainty whether an MSO would fall under the umbrella of “consulting” and if not, do their services then fall under the catchall provision related to skill and reputation of employees. Additionally, other tax sections have allowed the IRS to group activities rather than treat them as separate, and this could potentially override the form of the arrangement to eliminate the benefit.
Prior to the passage of the TCJA, Section 1202 was a section of the code that was not given much thought or further clarification via the tax court. The benefits of the section prior to 2009 were inconsequential, and, as a result, not much information is available as to the potential interpretations of this section. There have only been a few major rulings, which have indicated that the IRS has taken a more literal, narrow reading of this section rather than a broader interpretation. In one case, a company that provided testing and related reports for physicians, but did not diagnose or recommend treatment, did not rise to the level of healthcare. Another case struck down an IRS argument related to the skill and reputation for an insurance and related services sales firm, indicating its primary asset was its training and organization. As of the publication of this newsletter, the IRS has yet to release any additional regulations related to Section 199A or Section 1202, however it is high on their priority list, with a July 2018 expectation of more information. Taxpayers and tax professionals are left at a crossroads right now, without much of a roadmap.
An MSO can provide substantial non-tax benefits, such as access to capital and additional revenue streams for mature practices with administrative competitive advantages and a decrease in time spent by providers for administrative tasks. Often, however, these benefits were only realized by large practices as the economies of scale would not materialize for the smaller and mid-size practices. The list of benefits could potentially soon include substantial tax benefits, thereby making the formation of an MSO a near necessity for practices of all sizes.
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.