A "captive" professional corporation counts as a group member and can join the consolidated return, even though a licensed practitioner holds its stock

Plain-English summary

Many states forbid a regular company from owning a firm that practices a licensed profession (medicine, law, etc.); the stock must be held by a licensed practitioner. Businesses work around this with a "friendly" or "captive" professional corporation: a licensed practitioner holds legal title to the stock, but a management company in the corporate group captures all the economics through a services agreement and locks down the shares with a transfer restriction that automatically moves them to a group-chosen practitioner for a nominal price if the owner steps out of line. The question here was whether such a professional corporation is a member of the parent's affiliated group under § 1504(a), which turns on the group owning enough of the stock by vote and value. The IRS ruled that it is: because state law bars only legal (not beneficial) ownership by the group, and the agreements give the group all the economic benefit and effective control, the professional corporation is a group member and may join the parent's consolidated federal income tax return. The result lets the group fold the captive PC's income and losses into its consolidated return, consistent with Rev. Rul. 84-79.

Ruling snapshot

• Question: Is a state-mandated captive professional corporation, whose stock is legally held by a licensed practitioner, a member of the parent's affiliated group under § 1504(a) that may join the consolidated return?
• Outcome: approved
• Key authorities: IRC §§ 1504(a)(1), 1501, 1502; Rev. Rul. 84-79

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202049002                                              Third Party Communication: None
 Release Date: 12/4/2020                                        Date of Communication: Not Applicable
 Index Number: 1504.01-00
                                                                Person To Contact:
 -----------------------                                        ------------------, ID No. -----------------
 ----------------------------------------                       Telephone Number:
 ------------------------                                       --------------------
 ------------------------------                                 Refer Reply To:
 -------------                                                  CC:CORP:1
 --------------------------------                               PLR-107674-20
                                                                Date:
                                                                September 08, 2020




Legend

Parent                     =         ----------------------
-------------------------------------------------------------------
-----------------------------------------------------------

Sub                        =         ----------------------------
-------------------------------------------------------------------
-----------------------------------------------------------

Management Co              =         ----------------------------------------
------------------------------------------------------------------------------------
-----------------------------------------------------------

PC                         =         -----------------------------------------------------
------------------------------------------------------------------------------------
-----------------------------------------------------------

State X                    =        -------------

State Y                    =        -------------

Profession                 =        ------------

Professional               =        ----------

Practitioner               =        ------------
PLR-107674-20                                        2

Doctrine                 =   -----------------------------------------------------

Agreement 1              =   ---------------------------------

Agreement 2              =   --------------------------------------------------

a                        =   --

Opinion                  =   ---------------------------------

Date 1                   =   ------------------------

Firm                     =   ---------------------

Dear ----------------:

This letter responds to your February 28, 2020 request (“Request”), submitted by your
authorized representatives, for a ruling under section 1504(a) of the Internal Revenue
Code (“Code”). The information provided in that letter and in later correspondence is
summarized below.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalties of perjury statement
executed by an appropriate party. While this office has not verified any of the material
submitted in support of the request for a ruling, it is subject to verification on
examination.

FACTS

Parent wholly owns Sub and Sub owns all the interests in Management Co. Parent and
Sub are each a State X corporation and Management Co is a State Y limited liability
company. Parent is the common parent of an affiliated group of corporations filing a
consolidated federal income tax return (the “Parent Group”). Sub is a member of the
Parent Group.

PC is a State Y professional corporation engaged in the practice of Profession and is
subject to State Y’s Doctrine. This Doctrine provides that PC may only engage in the
practice of Profession through one or more Practitioners. This Doctrine further provides
that the shares of a corporation engaged in the practice of Profession generally may
only be issued to, held by, or transferred to one or more Practitioners. In the case of PC
the Practitioner that owns all of its stock is licensed to practice Profession in State Y
(“Practitioner Shareholder”). Parent does not currently file tax returns on a consolidated
basis with PC.

PC, through its Practitioner employees, conducts the aspects of its businesses that
constitute engagement in the practice of Profession. Under the terms of Agreement 1
PLR-107674-20                                  3

between Management Co, on the one hand, and PC, on the other, Management Co
performs all administrative and support services on behalf of PC in exchange for a fee.
Under the structure established in Agreement 1, Management Co is the only entity
entitled to any economic benefit resulting from PC’s operations. Finally, Management
Co also manages PC to the extent that such management does not constitute
engagement in the practice of Profession.

The Practitioner Shareholder holds legal title to all the issued and outstanding shares of
PC. The Practitioner Shareholder is party to Agreement 2. Pursuant to the provisions
of Agreement 2, the Practitioner Shareholder may not sell, assign, transfer, gift, pledge,
hypothecate, encumber or otherwise dispose of, whether voluntarily, involuntarily, by
operation of law or otherwise, any shares of the stock of PC. If the Practitioner
Shareholder violates this restriction, the stock automatically transfers to a designated
transferee (the “Designated Transferee”), without any further action by the Practitioner
Shareholder, for the nominal amount of $a per share. Any such Designated Transferee
is selected by Parent and will be a Practitioner permitted under State Y’s Doctrine to
directly hold the stock of PC. Agreement 2 further prohibits the Practitioner Shareholder
from authorizing, approving or declaring any dividend or other distribution with respect
to its stock or issue additional equity interests or rights to acquire additional equity
interests.

Parent received Opinion, dated Date 1, from Firm that the corporate structure described
in the Request (and summarized in this letter) would not violate State Y’s Doctrine.

REPRESENTATIONS

Parent, on behalf of Sub, makes the following representations:

   (a) PC has never declared nor paid any dividends, nor made other distributions, to
       any shareholder.

   (b) To the best of Sub’s knowledge, PC does not intend to declare or pay any
       dividends or make any other distributions, to any shareholder, except for
       distributions to Management Co or other members of the Parent Group. Sub
       intends to prevent PC from paying any dividends or making any other
       distributions to any other shareholder.

   (c) In the event the PC shares are transferred to a Designated Transferee pursuant
       to Agreement 2, such Designated Transferee will be required to execute a new
       Agreement 2 having terms substantially similar to the existing Agreement 2.

   (d) The legal arrangements created by Agreement 2 are valid and legally
       enforceable under applicable law.

   (e) Applicable law prohibits Sub only from: (i) practicing Profession, (ii) employing
       Practitioners to practice Profession, or (iii) controlling Practitioners’ Professional
PLR-107674-20                                 4

       decisions. As a result, applicable law prohibits only legal, and not beneficial,
       ownership of stock in PC by Sub.

   (f) PC is not: (i) a section 501 tax-exempt corporation, (ii) an insurance company
       subject to tax under section 801 of the Code, (iii) a foreign corporation, (iv) a
       regulated investment company, (v) a real investment trust, (vi) a domestic
       international sales corporation under section 992 of the Code, or (vii) an S
       corporation.

RULING

Based on the facts and information submitted and the representations made, we rule
that PC is a member of the Parent Group (within the meaning of section 1504(a)(1) of
the Code) and will be permitted to join in the filing of a consolidated federal income tax
return (within the meaning of sections 1501 and 1502 and the regulations thereunder)
with the Parent Group. Section 1504(a); Rev. Rul. 84-79, 1984-1 C.B. 190.
CAVEATS

We express no opinion about the tax treatment of the arrangements under other
provisions of the Code or regulations, or the tax treatment of any conditions existing at
the time of, or effects resulting from, the arrangements that are not specifically covered
by the above ruling. Furthermore, no opinion is expressed concerning the treatment of
any arrangements in taxable years for which income tax returns have already been
filed.

PROCEDURAL STATEMENTS

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, copies of this letter are
being sent to your authorized representatives.
PLR-107674-20                                 5

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

                                                  Sincerely,



                                                  Gerald B. Fleming
                                                  Senior Technician Reviewer, Branch 2
                                                  Office of Associate Chief Counsel
                                                  (Corporate)




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