‘Friendly doctor’ structures and state combined return considerations

Jan 14, 2021

As we previously discussed, the IRS has ruled in PLR 202049002 that entering into a management service agreement (MSA) between a Professional Corporation (PC) owned by a licensed professional and a management service organization (MSO) can result in transfer of ownership in the PC for tax purposes, despite the retention of legal ownership by the professional. Due to state medical licensing requirements, an MSO does not own legal title to a PC even though it controls many aspects of its operations through the MSA. For federal income tax purposes, when the MSO has the benefits and burdens of ownership, even though it does not have legal title to shares of the PC, the PC may be included in a consolidated return with the MSO. In the PLR, this consolidation was due to restrictions on the PC shareholder being able to transfer shares of PC stock and the prohibition of the PC shareholder from declaring a distribution with respect to the PC stock. In effect, the PC shareholder did not own the stock of the PC for tax purposes due to the above ownership restrictions, even though he owned legal title to the shares of the PC.

The MSO/PC relationship could have both risks and opportunities at the state level for federal consolidated filers. A summary of the state issues and a high-level review of several states are discussed below.

State income tax implications for federal consolidated filers

Certain states require commonly-owned corporations to file a combined return, similar to a federal consolidated return, if the corporations are engaged in a unitary business and certain ownership requirements are met.  However, while similar in some respects to the federal consolidated return rules, states do not automatically conform to the federal consolidated return regulations and therefore a separate state analysis must be conducted to determine whether a combined state return is allowed or required.

In the context of the MSO/PC relationship, even if the MSO and PC file as part of the same federal consolidated return, they may be required to file separate state income tax returns based on the state specific ownership requirements for combined returns. For example, both California and New York apply similar rules in determining whether commonly-owned corporations are required to file on a combined basis. These states both require a combined return when (1) at least 50% common ownership exists of stock that entitles voting power on the board of directors and (2) the existence of a unitary business. For purposes of this discussion, we will assume a unitary business exists and focus solely on the ownership requirement. As it relates to voting power on the board of directors, this requirement would only be met if the MSO had at least 50% voting power of the PC’s board of directors. Under a typical MSA, the MSO does have certain control and oversight of the PC but may not have any voting rights on the board of directors. This specific requirement may not impact the ability or requirement to file a federal consolidated return, assuming the benefits and burdens of ownership test are met, but a strict reading of the voting power requirement for California and New York purposes may prohibit the filing of a combined state return.  There is limited guidance in the states as it relates to voting power on the board of directors but it generally appears to be a specifically defined requirement that is not met, even if other ownership factors are present.

If an MSO does not have at least 50% of the voting power on the PC’s board of directors, and therefore cannot file as part of the same state combined return, there are certain consequences, including the following:

  • The inability to eliminate intercompany transactions such as fees paid by the PC to the MSO. This could result in a shifting of income and expense and payment of state taxes by the MSO on its MSA related income versus an offset of income and expense by the MSO and PC that generally occurs in a combined return.
  • The separate calculation of state apportionment factors by the MSO and PC as opposed to being able to combine them for state income tax purposes.
  • The need for documented transfer pricing to determine the arm’s length fees to be charged by the MSO to the PC under the MSA (and/or other agreements).
  • The inability of the PC to use net operating losses, depending on the terms of the MSA and amount it’s being charged by the MSO.

In contrast to California and New York, Florida allows a corporation that is subject to Florida corporate income tax that is the parent company of an affiliated group of corporations to elect to file a consolidated Florida income tax return. A parent corporation electing to file a Florida consolidated return must include the same members that are included in its federal consolidated return. Therefore, an MSO that has nexus in Florida that includes a PC in its federal consolidated return would seem to be able to elect to file a Florida consolidated return that includes the PC. This would result in the ability to eliminate intercompany transactions, compute a single apportionment factor and offset of income and loss of the corporations.

For Texas franchise tax purposes, certain unitary entities are required to file on a combined basis. Complexities exist given the regime is applicable to all taxable entities, regardless of entity type (e.g., corporation, partnership, limited liability company, etc.). Specifically, entities subject to the Texas franchise tax may be required to file on a combined basis if such entities are (1) unitary and (2) under common ownership, which may be legal or beneficial in nature.

Because the franchise tax is based upon total revenue minus certain enumerated subtractions and deductions, and not modified federal taxable income, combination may provide benefits from the elimination of intercompany receipts given the corresponding expense may not be deductible by an entity filing a separate return outside of a combined report. Additional considerations, including those stated above for California, Florida and New York, may also apply.

Though the unitary requirement may be more apparent, satisfying the common ownership requirement through ‘beneficial ownership’ may not be as clear cut. The applicable Texas statute and regulations do not provide a definition of beneficial ownership and guidance from the Texas Comptroller’s office may be limited. The beneficial ownership requirement appears to inherently require a facts and circumstances determination which may heavily rely on the terms of the MSO, as well as the de facto management and operations of the applicable entities. Therefore, analysis and potentially inquiry with the Texas Comptroller’s Office through available avenues may be prudent to either address risk, or capture potential benefit from a combination filing of includable unitary taxable entities.


Despite the fact that an MSO and PC are filing as part of the same federal consolidated return, they may not  necessarily be able to file as part of the same state combined return. Each state’s combined return rules must be analyzed to determine the state’s conformity, or lack thereof, to the federal consolidated return regulations, the states’ specific ownership requirements to file a combined return and the other applicable state guidance.

Taxpayers operating under this arrangement should consider evaluating their current filing to determine whether the filing is correct and whether there could be advantages to changing filing method. Such analysis may require modeling and an in-depth review of each taxpayers’ situation.

RSM contributors

  • Chris Gorman
    Senior Manager