01/03/2024

Entities interested in entering health care-related industries should consider compliance with business practice of medical doctrine. In a number of states, the corporate practice of medicine doctrine prohibits companies from practicing medicine or hiring a physician to provide professional medical services. Although some states prohibit the corporate practice of medicine, states provide an exception for professional corporations, and many states provide an exception for the employment of physicians by certain entities.

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The friendly-PC model is a common framework designed to conform to state corporate practice of medical doctrines. The friendly-PC model involves a professional services firm (PSC) conducting a medical practice in affiliation with a management services organization (MSO). When structured and operationalized correctly, the PC-friendly model is set to withstand allegations that the management company or its owners are violating the medicine’s corporate practice ban. See the following article for more information.

While the PC-friendly model may be a solution to corporate medicine doctrine practice, it can create unintended consequences for PSC and MSO-sponsored employee benefit plans.

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ERISA Subsidiary Group and Affiliated Service Group Rules

Employee benefit plans are subject to complex rules under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (Code). The controlled group and affiliated service group rules identify whether, for purposes of ERISA and the Code, two or more companies and certain other groups of related businesses or businesses are treated as a single employer.

If two or more employers are considered a single employer, various rules under ERISA and the Code apply on a controlled group basis. Controlled group rules generally prevent employers from splitting their employee population into separate entities — one that employs high-paying employees and the other that employs non-high-paying employees — to provide richer benefits to high-paying employees.

Controlled group rules

Under the controlled group rules, the following groups are treated as a single employer:

  • Parent groups. A parent-subsidiary group consisting of a parent company and its direct and indirect subsidiaries, at least 80% owned.
  • Brother-sister groups. A brother-sister grouping exists when the same five or fewer individuals, estates, or trusts own a controlling interest of at least 80% in one or more businesses or businesses, and the same five or fewer individuals, estates, or trusts own ( in the aggregate) more than 50% of each entity.
  • Combined parent-child and brother-sister groups. A mother-daughter group and a brother-sister group can be combined if the parent is a common member and the applicable requirements of both mother-daughter and brother-sister tests are met.

Applying these rules is more complicated than it might seem.

For the purposes of the regulation of the controlled group, some types of corporate equity investments are excluded. For example, non-voting stocks that are restricted and preferred with respect to dividends are excluded. In addition, some employee stock awards may be excluded for purposes of determining ownership of an entity.

The rules also include attribution rules, which treat certain people as having an interest in an entity they do not actually own. For example, an individual may be treated as the owner of shares held by one of her family members. For more information see the following article.

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In the context of a PC-friendly model, the PSC and the MSO are not usually part of the same controlled group of companies. The friendly-PC model typically does not involve a mother-daughter relationship (that is, a parent entity that owns at least 80% of a subsidiary) or a brother-sister group (that is, typically five or fewer individuals, estates, or trusts who own and control multiple entities).

Affiliated Services Group Rules

An affiliated services group (ASG) is similar to a subsidiary group, but analyzing the existence of an ASG involves more than the ownership structure of two or more entities. As a result, they often exist in the context of the PC-friendly model.

Determining whether an ASG exists requires a thorough analysis of the relationships between service organizations to determine whether the tests are met. An ASG consists of a designated first service organization (FSO) and another service organization, which the proposed regulations call an A organization (A-Org) or a B organization (B-Org). An ASG exists even if a management group exists.

  • First service organization. An FSO must be a corporation, partnership, or other organization primarily engaged in the provision of services, such as healthcare, consulting, and legal services.
  • A-Organization. An A-Org is a service organization that is a partner or shareholder of the FSO (regardless of the percentage stake it has in the FSO) and that:
    • performs regular services for the FSO; OR
    • is regularly associated with the FSO in carrying out services for third parties.

    Example: Dr. Smith incorporates his medical practice as a professional corporation, and that corporation is a partner in a medical practice with several other physicians who perform regular third party services. Dr. Smith’s incorporated medical practice is an A-Org and the medical partnership is FSO.

  • B-Organization. An organization is a B-Org if it satisfies these three tests:
  1. a significant portion of the B-Org’s business is performing services for the FSO or an A-Org of that FSO;
  2. the services that the organization provides are of the type historically performed by employees in the field of services of the FSO or A-Org; AND
  3. 10% or more of the interest in the B-Org is held by people who are highly paid employees of the FSO or the A-Org.

Example: Shiny Dental is a service organization with 11 partners. Each Shiny Dental partner owns one percent of the shares in Teeth Cleaning Corporation. Teeth Cleaning Corporation employees perform all dental cleanings at Shiny Dental. Teeth Cleaning Corporation is a B-Org because (1) a significant portion of its business is to provide services to Shiny Dental, (2) those services have historically been performed by dental service employees, and (3) 11% All interests in Teeth Cleaning Corporation are owned by Shiny Dental Partners.

  • Management groups. A management group exists when:
  1. an organization performs management functions; AND
  2. the main activity of the management organization is to perform management functions on a regular and continuous basis for a beneficiary organisation.

Example: Family Hospital creates a new company for the sole purpose of employing Family Hospital’s human resources and accounting departments. The new company is in a management group with Family Hospital and these two organizations form an ASG.

As noted above, the PC-friendly model often creates an ASG. Similar to the controlled group rules, employers in the SAG itself are treated as a single employer under the Code, but members of an SAG are Not treated as a single employer under ERISA. Inconsistent treatment of ASGs under the Code and ERISA leads to some strange outcomes for ASG-sponsored health plans, including:

  • Multi-Employer Welfare Agreement (MEWA). If a member of the ASG sponsors a group health plan for all employers in the group, the plan is a MEWA under ERISA, unless the ASG also meets the audited group tests under the Code . A MEWA is an employer-sponsored group health plan that does not meet the required percentage of common ownership for a controlled group (e.g. parent-daughter group or brother-sister group). MEWAs are subject to state law and state enforcement, which results in a higher administrative burden. Additionally, MEWAs with less than 25% common control must file Form M-1 with the federal government or face penalties in excess of $1,500 per day, even if the plan administrator was unaware that the plan was a MEWA.
  • Accessible Care Act (ACA). Notwithstanding the foregoing, ASGs are treated as a single employer for the purpose of determining whether an entity is an applicable large employer subject to the employer mandate and reporting rules of the ACA because that determination is made in under the rules of the Code, not ERISA.

Finally, special care must be taken in the friendly-PC model before giving stock compensation to employees or independent contractors. Incentive stock options, which benefit from favorable tax treatment, can only be granted to employees of the employing company or a related company (a parent company or subsidiary based on 50% common ownership). In addition, the deferred remuneration rules under section 409A of the code include an exception for certain share rights; however, this exception applies only if the stock grant grants an interest in the entity to which the individual provides services or in an entity that has a controlling interest in that entity. In the absence of this exception, most stock-based awards would be subject to section 409A of the code and would not comply with its complex rules.

Before establishing a PC-friendly model, organizations should analyze how the PC-friendly model will affect their employee benefit plans. The PC-friendly model may be a solution to corporate medicine doctrine practice, but it can create complex problems related to employee benefit plans. When designing a PC-friendly model, you should consult an ERISA qualified attorney familiar with these rules to ensure compliance and avoid common pitfalls.

Insights into employee benefits As part of Foley’s ongoing efforts to provide legal information to our clients and colleagues, our Employee Benefits and Executive Compensation group maintains a monthly newsletter we call “Employee Benefits Insights” where we provide you with updates on the latest and most pressing issues regarding employee benefits and other related topics. Click here or click the button on the left to sign up.

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