Friendly Doctor Structures
The IRS is reviewing questions of control and beneficial ownership in “friendly doctor” corporate structures to issue guidance, and it doesn’t encourage taxpayers to seek letter rulings at this time, according to an agency official. “This is probably not a good time for us to talk about the specific representations people may need to give” to get a letter ruling, said Julie Wang of the IRS Office of Associate Chief Counsel (Corporate), “because we really don’t encourage people to seek [letter rulings] on this at the moment while we’re studying this issue.” She spoke May 5 at a conference sponsored by the District of Columbia Bar Taxation Community.
So-called friendly doctor structures arise in states that require some licensed professionals — doctors, accountants, lawyers, and others — to own and control the professional corporations under which they practice. In recent years, some of those professional corporations have been acquired by larger holding companies and corporate groups. The arrangements use tiered stock ownership along with management and service agreements to transfer the economic benefits and burdens of ownership to the parent while leaving enough control and nominal title in the hands of the professionals to comply with state laws.
State Law Effects
Taxpayers have struggled to find reliable answers on whether their professional corporations are beneficially owned by the parent companies for tax purposes and whether they meet the definition of control under section 1504 for affiliated corporate groups. If a professional corporation qualifies as an affiliate under that section, it must be included in a consolidated group; if it doesn’t qualify, it can’t be included.
The IRS has generally required opinion letters with assurances under the relevant state laws about the legal effects of the agreements and ownership structures on those questions. However, as telehealth has flourished — increasing the practice of medicine across state lines — and more parent companies acquire professional corporations in multiple states, taxpayers and the IRS are navigating conflicting states’ laws. In November 2021 the American Bar Association Section of Taxation submitted a detailed comment letter requesting guidance on treatment of professional corporations as part of affiliated corporate groups.
Questions of Control
Wang explained that the tension between state laws and the control test under section 1504 is a main focus of the IRS’s study project. “We are aware of different arguments people have made on whether the group really meets the control requirement” in their ownership of the professional corporation, she said. “Some people have argued that [section] 1504 control is satisfied because through [management and service] agreements, the group can remove and replace the friendly doctor at any time without cause, so the group controls the friendly doctor,” Wang said. Others have argued that “potential bad-faith actions by these friendly doctors are very much relevant” because they can act on behalf of the professional corporation and the parent group’s only recourse would be suing for breach-of-contract damages, she said.
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