Experience rating your receivables.

• Author: Krantz, Kevin M.

As the health care industry responds to market demands for cost-effective quality care, the traditional physician-owned solo or small to mid-size group practice is being phased out of the market. These practices are evolving in several different directions, including joint ventures with hospitals or third-party payers, network affiliations of individual practices or large group practices. These new entities differ structurally from the traditional group practices in that they tend to be larger, employ more nonowner physicians, are more capital intensive, may include a not-for-profit owner and are more likely to be "related" by common ownership to other entities. The tax planning strategies commonly employed by conventional practices may not apply to these new entities because of the structural differences. These newer entities may have more in common with other service businesses than with the conventional medical practice, and tax advisers must react accordingly.

One basic but important issue is the entity's method of accounting. Traditionally, medical practices have elected the cash basis of accounting. They have relied on the exception to the accrualbasis requirements for qualified personal service corporations (QPSCs) provided by Sec. 448(b)(2) or the exception for entities with average gross receipts for the last three years of not more than $5 million provided by Sec. 448(b)(3) to avoid the accrual method.

A QPSC, for this purpose, is defined in Sec. 448(d)(2) and the accompanying regulations as a service organization that meets both the "function" and "ownership" tests. To qualify as a PSC, the corporation must provide services in one of eight qualifying fields, and at least 95% of the stock must be owned by current employees who perform personal services for the corporation or retired employees (or their estates). Nonprofessional service businesses provide services outside of the eight qualifying fields and fail the function test. Many new medical practices are structured in a way that fails the ownership test. From a tax planning standpoint, these non-PSC medical practices are now the equivalent of nonprofessional service businesses, and cannot rely on Sec. 448(b)(2) to be able to use the cash basis of accounting.

Newly formed medical ventures tend to be larger in size and many include some ownership by a hospital. By virtue of these things, many of them will have gross receipts in excess of $5 million and will not fit into the...