Doctor recapitalization transactions are complicated by nature and infrequently current myriad points. At Foley, in our illustration of each traders in, and sellers of, doctor practices, we word how usually tax points turn out to be gating gadgets that drive the structural elements of the transaction. These tax points typically come up on account of (a) the goal apply’s pre-signing tax construction, (b) the character of the transaction consideration and the way it is going to be paid, and (c) post-closing operational and compensation issues.
Understanding these points and attaining alignment between personal fairness traders and doctor apply sellers is vital to optimizing transaction objectives and efficiently navigating from the letter of intent to closing. In our expertise, such evaluation and alignment are greatest addressed early within the course of when it’s a lot simpler to each implement adjustments in addition to socialize the problems with the assorted constituencies.
Separating Rollover Fairness from the Goal Apply
Doctor practices are sometimes (and traditionally) organized as Subchapter C or Subchapter S companies for federal and state earnings tax functions, each of which current challenges in reference to these transactions. That is notably true the place the doctor homeowners will obtain a good portion of the transaction consideration in fairness of the investor-owned administration firm (MSO) or its guardian. This fairness is sometimes called “rollover” fairness.
The commonest doctor recapitalization transaction construction is the cost of money and rollover fairness (which is usually as a lot as 40 p.c of complete enterprise worth of the promoting apply) to the promoting physicians and apply. The promoting physicians and apply all the time want that the receipt of rollover fairness be tax deferred. Whereas the money is comparatively simple to distribute from the goal apply to the doctor homeowners, the rollover fairness presents a difficulty when the apply is organized as a C or an S company. Not like an entity taxed as a partnership, the place the rollover fairness might often be distributed by the apply on to the doctor homeowners with none instant tax penalties, if apply is taxed as a C-corporation or an S-corporation, such a distribution would end in an instantaneous recognition of acquire by the recipient physicians (i.e., vitiating the tax deferred remedy).
These tax constructions turn out to be notably problematic the place the goal apply goes to be the “platform apply” for the MSO, in that occasion the events should separate the rollover fairness from the operation of the goal apply necessitating a pre-closing reorganization (usually known as a “pop-up” F reorganization) of the apply that’s designed to protect (i) the present federal employer identification quantity (EIN) of the apply (in order to protect relationships with payors, and apply money move) and (ii) the tax deferred remedy of the rollover fairness to the physicians.
Deferred Funds and Imputed Curiosity
Lately, sure doctor recapitalization transactions have concerned deferred funds. Consumers usually make any such funds contingent on a doctor’s persevering with employment on the time funds are made. Whereas such deferred funds sometimes obtain “installment sale” remedy underneath the Inner Income Code (Code) (that means that tax is deferred till the time the cost are literally obtained),1 if curiosity shouldn’t be paid on these quantities, the IRS will impute curiosity. This imputed curiosity ends in a re-characterization of a portion of every deferred buy value cost as curiosity, with such curiosity taxed as peculiar earnings, as a substitute of capital features and, thus, at greater marginal tax charges.
Allocations of Buy Worth
It’s common for doctor homeowners to allocate buy consideration in a fashion that displays every doctor’s contribution towards apply EBITDA.2 Whereas an entity taxed as a partnership gives flexibility in how distributions could be made, distributions by a C-corporation or an S-corporation have to be made in accordance with share possession. Since doctor practices are usually owned in equal proportions rewarding doctor sellers in a fashion that doesn’t observe proportion possession within the apply can create its personal set of tax points if, for instance, a doctor receives a proportion of the acquisition consideration that exceeds his or her proportion possession curiosity within the goal apply.
Essentially the most tax environment friendly option to handle this disconnect is to construction a portion of the transaction consideration as a sale of non-public goodwill by the person physicians. Such proceeds sometimes qualify for capital features remedy and could be structured to adjust to the physicians’ want to mirror relative contributions towards EBITDA. Sadly, a sale of non-public goodwill is barely attainable the place there is no such thing as a present non-compete between the physicians and the apply (i.e., the doctor, not the apply, owns the goodwill in query).
Absent the provision of non-public goodwill sale, there are few alternate options apart from treating the quantities paid to a doctor in extra of his or her proportion possession within the goal apply as “bonus” compensation and, thus, peculiar earnings.3
Redemptions of Departing Physicians
As famous above, most doctor recapitalization transactions contain a rollover contribution by the promoting physicians on a tax deferred foundation. Subsequent doctor departures, whether or not on account of termination, retirement, or different causes, sometimes give rise to non-compulsory or obligatory redemption of that rollover with the acquisition value typically various relying on the circumstances of that departure. Whereas it’s anticipated that the redemption of the departing doctor would end in acquire being acknowledged by that doctor, the place the rollover is held by promoting physicians by way of an S-corporation the style through which that rollover is redeemed may end in tax penalties for all of the promoting physicians. Sometimes, the MSO’s governing paperwork require that redemption of a departing doctor that owns by way of holding firm be structured as a purchase order by the MSO (or its guardian) of a portion of the full rollover held by that holding firm that displays the departing doctor’s professional rata possession therein, with the holding firm then making a “back-to-back” redemption of the departing doctor’s fairness within the holding firm itself. Sadly, when the holding firm is an S-corporation, the acquire acknowledged when the S-corporation sells rollover in step one of the method is allotted amongst all the doctor homeowners of the S-corporation in proportion to their possession of the S-corporation. Accordingly, the non-departing physicians might owe tax in reference to such departure.4
A extra tax environment friendly various is to grant the S-corporation a proper of first refusal with respect to the departing doctor’s rollover within the S-corporation with none requirement of a redemption by the MSO of the fairness owned straight by the S-corporation itself. On this occasion, not one of the remaining physicians incur any tax on account of the sale. The payout to the departing doctor could be structured as a word for some or all the redemption quantity, with such funds phrases because the events want, together with a balloon cost upon a change of management or different liquidation occasion with respect to the MSO.5
Affiliate Doctor Participation
Practices usually want to reward junior/affiliate physicians to the extent they don’t seem to be in any other case collaborating within the transaction. This can sometimes take the type of money bonuses payable over time so as to encourage retention. Since the price of these bonuses is mostly borne by the promoting physicians, however is paid by the apply, correct structuring is important to make sure that the promoting physicians retain the good thing about the tax deduction related to the cost of such bonuses.
An extra incentive to affiliate physicians to align their pursuits extra carefully with the apply post-closing is to grant these physicians so-called “income pursuits” which take part sooner or later development of the enterprise and never within the present worth of the enterprise on the time the pursuits are granted. Consequently, a nominal (or no) money outlay is required and the issuance doesn’t end result within the incurrence of any current tax legal responsibility. Accordingly, income pursuits are engaging.6 Such pursuits could be topic to such vesting and repurchase provisions as are desired, though sometimes the MSO will wish to have some management and/or perception into these phrases. Cautious structuring is crucial to making sure the specified tax end result, together with the style through which the worth of the enterprise is decided on the time of every such issuance.
Non-public fairness recapitalization transactions are complicated preparations, with tax points including to the complexity. Cautious consideration of those points as early as attainable within the deal negotiations is essential to make sure that the transaction is as tax environment friendly to the events as attainable.
Foley is right here that can assist you handle the short- and long-term impacts within the wake of regulatory adjustments. We have now the assets that can assist you navigate these and different necessary authorized concerns associated to enterprise operations and industry-specific points. Please attain out to the authors, your Foley relationship companion, or to our Well being Care Apply Group or Tax Apply Group with any questions.
1 Care ought to be taken to keep away from treating such funds as compensation earnings topic to peculiar earnings tax charges, and with a C company, probably topic to excise tax underneath the necessities of 280G of the Code (extra parachute funds).
2 In different items present in Foley’s Well being Care Regulation At this time now we have detailed the style through which physicians create ahead trying EBITDA (earnings earlier than curiosity, taxes, depreciation, and amortization) by agreeing to proportion reductions (or “scrapes”) of their future compensation. These physicians who take the best quantity of scrape are typically rewarded with extra of the money buy value than those that take lesser scrapes.
3 Cautious structuring is necessary with respect to any such preparations so as to be certain that the entity receiving the transaction proceeds is ready to take the corresponding deduction for the cost of such bonuses. Lack of such deduction may end result within the vendor paying tax on the transaction proceeds along with the doctor paying tax as compensation.
4 Doctor holding corporations will usually attempt to handle this problem by having the departing doctor indemnify the opposite physicians in respect of their tax prices (or in any other case defer a portion of the upfront cost to the departing doctor in an quantity equal to such tax prices) which brings its personal set of points and concerns.
5 The place the promoting physicians have been capable of negotiate this provision with the personal fairness investor, such proper is usually topic to the S-corporation sustaining a sure minimal degree of doctor possession to keep away from concentrating MSO possession in too few collaborating physicians.
6 There are numerous methods and strategies of issuing such pursuits, every of which is pushed by tax construction.