58: The Evolution of the Affiliated Service Group S. Derrin Watson

Transcription

1 58: The Evolution of the Affiliated Service Group S. Derrin Watson

2 TRADITIONAL AFFILIATED SERVICE GROUPS UNDER CODE 414(M)

3 Lack of guidance 1980: Congress passes 414(m) to provide for traditional ASGs 1981: IRS issues Rev. Rul First guidance on ASGs Gave us key terminology 1982: Congress passes 414(m)(5) to provide for management function groups 1983: Treasury issues proposed ASG regulations limited to traditional ASGs Taxpayers may rely 1984: Congress amends 414(m) to change attribution rules

4 Traditional ASG consists of A first service organization (FSO) any service organization will do and One or more A-Orgs and/or B-Orgs

5 Traditional ASGs focus on service organizations If entity is not a service organization, it cannot be an FSO or an A-Org Two ways to be a service organization In the fields of Health Law Engineering Architecture Accounting Actuarial science Performing arts Consulting Insurance An organization for which capital is not a material income producing factor, considering all facts and circumstances Capital is material: For banks and similar organizations If substantial investment in inventory, equipment, plant, and machinery Capital is not material if income primarily from fees/commissions for personal services

6 Case study: Service organizations Are the following businesses service organizations? a) A hospital b) A pro baseball player c) A wheelchair manufacturer d) A grocery store e) An author f) A bank g) An insurance company h) A veterinarian with significant equipment i) A neighborhood real estate broker j) A spa k) A restaurant

7 A-Org Meet These Requirements: It must be a shareholder or partner in the FSO Any ownership, no matter how small, will do It can be deemed ownership It must be a service organization Based on all facts and circumstances (including revenue) it must either: Regularly perform services for the FSO, or Be regularly associated with the FSO in providing services to third parties

8 Classic A-Org relationship Jones and Smith is a partnership practicing law. Its partners are Jones, Inc. and Smith, Inc. The two corporations each employ one attorney. The staff members work for the partnership. Jones and Smith is an FSO The two corporations are A-Orgs The three together are an ASG Jones & Smith (FSO) Jones Inc. (A-Org) Smith, Inc. (A-Org)

9 Dr. Ross owns 20% of PQRST Clinic (a partnership) Outpatient surgery Dr. Ross owns 5% of Outpatient Surgery Center (OPSC, an LLC taxed as a partnership) center Clinic regularly performs surgeries at OPSC Accounts for 30% of Clinic s revenues Patients get 2 bills, one from Clinic, one from OPSC Attribution applies: Clinic is deemed to own Ross s OPSC interest OPSC is deemed to own Ross s Clinic interest If you consider the Clinic as the FSO, is OPSC an A-Org? If you consider OPSC the FSO, is Clinic an A-Org?

10 Perry is sole practitioner criminal attorney Billem Of counsel & Gougem, law attorney firm, lists Perry as of counsel Refer all criminal work to Perry Perry advises Firm on criminal aspects of civil cases Perry derives substantial revenues from The Firm itself and The clients the Firm refers Perry and Firm are service organizations Perry and Firm are regularly associated in providing services to third parties Are Perry and Firm an ASG

11 Professional Service Corporation Exemption For purposes of the A-Org test, the FSO must either: Be unincorporated, or Be a professional service corporation Professional service corporations are licensed under state law to provide services of public accountants, actuaries, architects, attorneys, chiropodists, chiropractors, medical doctors, dentists, professional engineers, optometrists, osteopaths, podiatrists, psychologists, and veterinarians.

12 Jack owns 100% of Good Pills 1, a Los Angeles pharmacy A tale of two Jack owns 75% of Good Pills 2, an Ontario pharmacies pharmacy The pharmacies are separately incorporated Jack manages both stores The name on each store is Good Pills They share a website They advertise together Neither performs services for the other Are they an ASG?

13 B-Orgs meet these requirements: At least 10% of the B-Org is owned by HCEs of the FSO or its A-Orgs. A significant part of the B-Org s business is performing services for the FSO or its A-Org s of a type historically provided by employees. Significant? 5% or less never is, 10% or more always is Historically performed: It was not unusual for the services to be performed by employees of organizations in that service field December 13, 1980 B-Org need not be a service organization.

14 Aaron, Classic Betty, Charles, B-Org Doreen, and Evan are each doctors, and each owns 100% of a medical corporation. Each owns 20% of Doctors Billing Company. Doctors Billing company does billing services for the 5 doctors. Doctors Billing Company is a B-Org of each of the 5 FSO medical corporations. How can they avoid this result?

15 ASG rules are fuzzy Regularly associated, historically performed by employees, etc. rules are not black and white. You cannot request a determination letter on ASG status

16 ASG ATTRIBUTION RULES

17 ASG Attribution - Options If I own an option to buy an interest in a business, it is as though I owned that interest outright

18 ASG Attribution Entities Pro rata from: Attribution from entity Partnership to partner S Corporation to shareholder Trust to beneficiary No attribution from retirement trust A shareholder owning at least 50% of the value of a C corporation s stock is deemed to own his pro rata share of what the corporation owns For HCE and key employee, drop that to 5% Attribution to entity Essentially, corporations, partnerships and trusts are deemed to own everything held by their owners/beneficiaries The only exception is C corporations, which are deemed to own interests held by shareholders owning at least 50% of the value of the C corporation

19 ASG Attribution Families I am deemed to own stock held by my: Spouse No noninvolvement exception Even if interlocutory divorced No attribution if legally separated or divorced Children (regardless of age) Grandchildren Parents (but not grandparents)

20 Capitalist Medical is a C corporation owned equally by Dr. Salt and Dr. Pepper Surgery Center Salt and Pepper each own 5% of Freedom Surgery Center, a partnership CM derives 20% of its income by performing procedures at FSC CM and FSC bill separately for their services/facility No money flows between CM and FSC. a) Are CM and FSC an ASG? b) Does the answer change if CM has a third owner, Dr. Denton, (also a 5% partner in FSC)? c) Does the answer change if CM has three partners and both CM and FSC are C corporations?

21 MANAGEMENT FUNCTION GROUPS UNDER CODE 414(M)(5)

22 Management Function Groups 414(m)(5): For purposes of this subsection, the term "affiliated service group" also includes a group consisting of-- (A) an organization the principal business of which is performing, on a regular and continuing basis, management functions for 1 organization (or for 1 organization and other organizations related to such 1 organization), and (B) the organization (and related organizations) for which such functions are so performed by the organization described in subparagraph (A).

23 What s a Management Function? We don t know. In the absence of a regulatory definition, look at common English usage A management function is what managers do Hire, fire Set policies Supervise Run business

24 What is Principal Business Purpose? We don t know IRS in determination letter applications would check percentage of revenues that come from managing Could also be based on time spent In any event - the principal purpose needs to be the top dog

25 Is a corporate director performing management functions? We don t know At conferences, IRS has gone both ways Committee reports would indicate not, especially for outside directors

26 Practice Dr. Gannon turns over the management of his practice to Acme Practice Management (APM). APM takes care of Management staffing, negotiates contracts with insurance companies, determines what equipment will be purchased, etc. APM does not have any other clients. Gannon does not own any interest in APM. Are the practice and APM a management function group? Does the answer change if APM expands its business and now has three unrelated clients, who take up roughly equal amounts of its time and pay equivalent amounts for its services?

27 Radiology centers X-Ray Spot (XS) is a publicly-held C Corporation which owns a chain of radiology imaging centers in 40 states. Freestanding facilities furnished with radiology equipment and trained technicians. Physicians refer patients to a center for MRIs and similar procedures. Independent radiologists with their own practices read the results and transmit their findings to the referring physician. Patients are separately billed by the radiologist and by XS.

28 Radiology center questions 1. Is XS a service organization? 2. Can XS be the FSO of an A-Org? 3. Is XS in an A-Org style ASG with one of the radiologists 4. XS in an A-Org style ASG with FGH? 5. Do the radiologists provide services historically performed by employees of imaging centers? 6. XS in a B-Org style ASG with a radiologist? 7. Is XS in a management function group with a radiologist? 8. Is XS related to a radiologist? 9. Are XS employees leased employees of a radiologist?

29 Questions? S. Derrin Watson, Esq Kent Place Goleta, CA