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B-Orgs and Significant Services
(Posted April 8, 2002)
Question 152: A group of 6 doctors formed a partnership 20 years ago. They also formed a separate partnership to manage a billing office. The billing office now does billing for the doctors' partnership and for 40 other doctor groups. Only 3 of the original partners remain. 10 other partners are now part of the doctors' partnership but not part of the billing office partnership. Is the billing office still part of an affiliated group?
Answer: It depends, but probably not.
Let's look at the medical partnership as a First Service Organization (FSO) and see if the billing office meets the B-Org requirements. According to IRC 414(m), for an organization to be a B-Org it must meet the following requirements:
- A significant portion of its income must come from performing services for the FSO or its A-Orgs; and
- Highly compensated employees of the FSO or its A-Orgs must own at least 10% of the B-Org
The second requirement is easily met. HCEs of the FSO own 100% of the billing firm. The ownership changes in the FSO really don't change anything here.
The first requirement turns on the definition of "significant portion." According to the proposed regulations, performance of employee services for the FSO or its A-Orgs is a significant portion of a company's business if it accounts for at least 10% of its income. It is absolutely not significant if those services account for less than 5% of its service related income. Otherwise, look at all facts and circumstances (in other words, get a determination letter).
You've said that the billing company does work for 40 practices, only one of which is the medical partnership in question. Thus, it would seem likely that the FSO's payments to the billing office constitute less than 5% of its total service revenue. However, that's just a guess, and you need to look at actual numbers. Check carefully for affiliated status if any members of the medical partnership are part of other firms for which the billing office performs services.
Having dealt with B-Org status, we should quickly check in with A-Org status. Again, we view the medical partnership as an FSO. Is the billing firm an A-Org?
After applying the attribution rules of IRC 318, it is an owner or shareholder in the medical practice, because it is deemed to own the partnership interests held by its owners. Moreover, it performs services for the medical practice-- but are those services performed "regularly"? Again, we turn to the proposed regulations, where we learn, "One factor that is relevant in making this determination is the amount of the earned income that the organization derives from performing services for the First Service Organization, or from performing services for third persons in association with the First Service Organization."
The regulations imply that if the revenue that the prospective A-Org derives from performing services for the FSO is trivial, then it will not be deemed to be regularly performing services for the FSO. If it's a close call, your best course of action is to seek a determination letter from the IRS on this point. However, I'd say as a general rule that if the FSO accounts for less than 5% of its gross receipts (the same test used for B-Orgs), then this test is not passed and an ASG does not exist.
Affiliated service groups are discussed in chapter 13 of my book Who's the Employer.
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