MEMORANDUM
PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGED / ATTORNEY WORK PRODUCT
From: Calderwood & Harkness LLP Leonard Cross, Partner, Tax Robert Jansen, Senior Associate, Tax
To: Ardent Capital Partners III LP Marcus Pellegrino, Partner, Healthcare Claire Ashworth, Co-Founder & Managing Partner
Date: May 31, 2024
Re: Closing Tax Summary — Acquisition of Pinnacle Health Services Group LLC
Engagement No.: 1001-00006 Matter No.: 1001-00006
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I. Executive Summary
The purpose of this memorandum is to summarize all tax elections, filings, compliance obligations, and action items arising from the closing of the acquisition of 100% of the membership interests in Pinnacle Health Services Group LLC ("Pinnacle" or "PHSG") by Ardent Healthcare Intermediate Inc. ("Intermediate"), a wholly owned subsidiary of Ardent Healthcare Holdings LLC ("Holdings"), which occurred on May 31, 2024 (the "Closing Date"). This memorandum is intended to serve as a comprehensive reference document for the Ardent Capital Partners III LP ("Fund III") deal team and should be read in conjunction with the Merger Agreement dated March 15, 2024 (the "Merger Agreement"), the ancillary transaction documents, and the tax opinion letters and schedules delivered at or prior to closing.
Transaction Structure. The acquisition was structured as a reverse merger of Ardent Healthcare Merger Sub LLC ("Merger Sub"), a newly formed Delaware limited liability company and wholly owned subsidiary of Intermediate, with and into Pinnacle, with Pinnacle surviving the merger as a wholly owned subsidiary of Intermediate. The reverse merger structure was selected, among other reasons, to preserve Pinnacle's existing contractual relationships, payor contracts, Medicare and Medicaid provider agreements, state healthcare licenses, and other regulatory approvals that might otherwise require assignment, consent, or re-issuance in a forward merger or asset acquisition.
Valuation. The transaction was consummated at an enterprise value of $412,000,000 and an equity value of $339,400,000. The equity value was derived by subtracting net debt of $72,600,000 from the enterprise value, with net debt consisting of $81.3 million of funded indebtedness outstanding at closing less $8.7 million of cash on the balance sheet.
Effective Tax Date. The effective tax date of the transaction is May 31, 2024, corresponding to the Closing Date. All tax elections, computations, and allocations described herein are determined with reference to this date.
Organization of Memorandum. This memorandum is organized into the following sections:
(I) Executive Summary; (II) Transaction Structure at Closing; (III) Section 754 Election; (IV) Section 743(b) Basis Step-Up Computation; (V) Section 83(b) Elections for Rollover Participants; (VI) Rollover Equity Treatment; (VII) Nonresident State Withholding Obligations; (VIII) Tax Escrow Deposits; (IX) Form 8308 Filing Obligation; (X) Purchase Price Allocation; (XI) Tax Receivable Agreement Effective Date; (XII) FIRPTA Certificates; (XIII) Other Closing Tax Deliverables; (XIV) Post-Closing Filing Calendar and Action Items; (XV) Coordination and Contacts; and (XVI) Conclusion.
Each section identifies the relevant statutory authority, the actions taken or required, the parties responsible for compliance, and any outstanding deadlines or action items. We have highlighted critical post-closing action items and deadlines throughout the memorandum, particularly the June 30, 2024 deadline for filing Section 83(b) elections with the Internal Revenue Service, the failure to comply with which would have material adverse tax consequences to the rollover participants.
This memorandum does not address all federal, state, and local income tax issues that may arise from the acquisition or ongoing operations of Pinnacle, nor does it address employment tax, sales and use tax, or other non-income tax matters except to the extent specifically noted. A separate Post-Closing Tax Integration Memorandum is expected to be delivered on or about June 14, 2024, and will address ongoing compliance obligations, the estimated tax payment schedule, and TRA administration in greater detail.
II. Transaction Structure at Closing
A. Overview of Closing Structure
The acquisition was implemented through a three-tier acquisition structure designed to achieve the following objectives: (i) facilitate the flow-through of partnership-level tax deductions (including the Section 743(b) basis step-up amortization) to Intermediate and, ultimately, to Holdings; (ii) block unrelated business taxable income ("UBTI") from flowing to tax-exempt limited partners of Fund III through the interposition of a C-corporation blocker entity (Intermediate); (iii) isolate state tax nexus at the Intermediate level; and (iv) preserve the option of a future initial public offering through a corporate entity. The three tiers are described in detail below.
Tier 1: Ardent Healthcare Holdings LLC. Holdings is a Delaware limited liability company (EIN 93-2187445; Delaware Secretary of State File No. 7834219). Holdings is classified as a partnership for federal income tax purposes under its default classification; no election on Form 8832 (Entity Classification Election) has been filed to change this classification. Holdings serves as the equity aggregator for all sources of equity capital in the acquisition, including: (a) Fund III's committed equity of $198.5 million; (b) rollover equity contributions from the three rollover participants totaling $59.54 million; (c) management incentive equity (profits interests) to be issued pursuant to the Management Equity Plan adopted by the Board of Managers of Holdings on May 28, 2024; and (d) mezzanine warrants entitling Cascadia Mezzanine Fund IV LP to acquire equity interests in Holdings representing 2.5% of fully diluted equity in Holdings. The limited liability company agreement of Holdings (the "Holdings LLC Agreement") was executed on May 28, 2024, and became effective upon the Closing Date.
Tier 2: Ardent Healthcare Intermediate Inc. Intermediate is a Delaware C-corporation (EIN 93-2187512; Delaware Secretary of State File No. 7834223), incorporated on March 8, 2024, and wholly owned by Holdings. Intermediate was interposed between Holdings and Pinnacle primarily for the purpose of blocking UBTI for tax-exempt limited partners of Fund III, including endowments, pension funds, and other institutional investors that are exempt from federal income tax under Section 501(a) of the Internal Revenue Code (the "Code"). Under Section 512 of the Code, a tax-exempt organization's share of income from a partnership engaged in a trade or business unrelated to the organization's exempt purpose constitutes UBTI. By interposing Intermediate as a C-corporation between Holdings and Pinnacle, income from Pinnacle's operations is subject to corporate-level tax at Intermediate rather than flowing through to Holdings and its tax-exempt partners. Additionally, Intermediate isolates state tax nexus and positions the combined enterprise for a potential future IPO through a corporate vehicle.
Tier 3: Pinnacle Health Services Group LLC. Pinnacle is a Delaware limited liability company (EIN 82-1947632), formed on August 12, 2016. Pinnacle has been classified as a partnership for federal income tax purposes since its formation; no check-the-box election (Form 8832) has been filed at any time to change this classification. Pinnacle's Operating Agreement was executed on August 12, 2016 and subsequently amended on March 3, 2020. Following the closing of the reverse merger, Pinnacle is now wholly owned by Intermediate and continues to be treated as a disregarded entity for federal income tax purposes with respect to Intermediate (as Pinnacle's sole member). However, for purposes of the Section 754 election and the Section 743(b) basis adjustment, the transaction is analyzed as if Intermediate acquired 100% of the membership interests in Pinnacle while Pinnacle is treated as a partnership, because the acquisition is structured as a purchase of partnership interests (reverse merger into the target partnership) rather than an asset acquisition.
Merger Sub. Ardent Healthcare Merger Sub LLC is a Delaware limited liability company (Delaware Secretary of State File No. 7834227), formed on March 8, 2024 as a wholly owned subsidiary of Intermediate for the sole purpose of effecting the reverse merger. At closing, Merger Sub merged with and into Pinnacle, with Pinnacle surviving as the surviving entity. Upon effectiveness of the merger, Merger Sub ceased to exist, and all of the outstanding membership interests in Pinnacle formerly held by the pre-closing members (including Dr. Raymond Carvallo, Dr. Nadia Ostrowski, Jonathan Farnsworth, and the 14 minority physician-investors) were converted into the right to receive the merger consideration (consisting of cash and, for the rollover participants, a combination of cash and Class B Units of Holdings).
B. Sources and Uses at Closing
The following table summarizes the sources and uses of funds at closing:
Sources of Funds:
The Term Loan B syndicate members include Ridgepoint Capital Markets LLC and Thorncrest Credit Partners LP, each of which participated in the syndication of the term loan facility arranged by Graystone National Bank, N.A. as administrative agent and lead arranger.
Uses of Funds:
The working capital target under the Merger Agreement is $18,200,000. Estimated closing working capital as of the Closing Date is $19,050,000, representing an estimated surplus of $850,000 relative to the target. This surplus, if confirmed in the post-closing working capital true-up, will result in an additional payment from the buyer to the sellers. The post-closing true-up process is governed by Section 2.06 of the Merger Agreement, and the final determination is expected to be completed within 90 days of the Closing Date.
C. Pinnacle Tax Classification Confirmation
Pinnacle has been classified as a partnership for federal income tax purposes continuously from its formation on August 12, 2016 through the Closing Date. We have reviewed the following documentation in confirming this classification:
(a) Pinnacle's Operating Agreement dated August 12, 2016 (as amended March 3, 2020), which provides for multiple members and the allocation of income, gain, loss, deduction, and credit in a manner consistent with partnership tax treatment;
(b) A search of the IRS Form 8832 database (conducted through the Practitioner Priority Service line on March 22, 2024), which confirmed that no Form 8832 has been filed by or on behalf of Pinnacle at any time;
(c) Pinnacle's federal partnership income tax returns (Form 1065) for the taxable years ending December 31, 2018 through December 31, 2023, which were reviewed and confirmed to have been filed consistent with partnership classification; and
(d) The Seller's Tax Closing Certificate dated May 31, 2024, executed by the sellers' representative, which certifies that (i) Pinnacle has at all times been classified as a partnership for federal income tax purposes, (ii) no election on Form 8832 has been filed to change Pinnacle's classification, (iii) there are no outstanding federal, state, or local tax liabilities other than as disclosed in the schedules to the Merger Agreement, and (iv) Pinnacle is in compliance with all applicable state tax withholding and filing obligations.
Based on the foregoing, we are satisfied that Pinnacle was properly classified as a partnership for federal income tax purposes as of the Closing Date, and that the reverse merger constitutes a sale or exchange of partnership interests for federal income tax purposes, giving rise to the Section 743(b) basis adjustment described in Section IV below.
III. Section 754 Election
A. Election Requirement
Pursuant to Section 6.04(c) of the Merger Agreement, Pinnacle is required to make an election under Section 754 of the Internal Revenue Code for its taxable year that includes the Closing Date. Section 754 of the Code provides that a partnership may elect to adjust the basis of its property in the case of a transfer of a partnership interest (under Section 743(b)) or a distribution of partnership property (under Section 734(b)). In the context of this transaction, the Section 754 election is critical because it permits Intermediate, as the acquiring partner, to receive a basis adjustment in Pinnacle's assets equal to the difference between the purchase price paid for the partnership interests and Intermediate's proportionate share of the inside basis of Pinnacle's assets.
The Section 754 election, once made, is irrevocable absent the consent of the Internal Revenue Service. Accordingly, the election will apply not only to the taxable year ending December 31, 2024, but to all subsequent taxable years of Pinnacle unless the IRS grants permission to revoke the election pursuant to Treasury Regulations Section 1.754-1(c). Given that Pinnacle will be wholly owned by Intermediate following the closing and no additional transfers of partnership interests are anticipated in the near term, the irrevocability of the election is not expected to create any adverse consequences.
B. Filing Mechanics
The Section 754 election is made by attaching a written statement to the partnership's timely filed federal income tax return (including extensions) for the taxable year during which the election is to take effect. In this case, the election statement must be attached to Pinnacle's Form 1065 for the taxable year ending December 31, 2024. Pinnacle's Form 1065 is due on or before March 15, 2025, subject to a six-month automatic extension to September 15, 2025 if a timely extension request (Form 7004) is filed.
Calderwood & Harkness LLP has prepared a draft Section 754 election statement, which was delivered separately as a stand-alone document dated May 31, 2024. The election statement identifies the electing partnership as Pinnacle Health Services Group LLC (EIN 82-1947632), sets forth the name and address of the partnership, and declares that the election is made under Section 754 of the Internal Revenue Code and Treasury Regulations Section 1.754-1(b)(1). The statement further provides that the election applies to all distributions of partnership property and transfers of partnership interests occurring during the taxable year ending December 31, 2024, and all subsequent taxable years.
The responsibility for attaching the election statement to Pinnacle's 2024 Form 1065 rests with Pinnacle's post-closing tax return preparer. Calderwood & Harkness LLP has delivered the draft election statement to Caldwell Pratt & Moorehouse LLP ("CPM"), which has been engaged as the buyer's accountants and will be responsible for the preparation of Pinnacle's post-closing tax returns, as well as the coordination with Brewer Stanfield & Associates LLP ("BSA"), the target's pre-closing accountants, with respect to the pre-closing period return items. CPM has confirmed receipt of the draft election statement and its intention to include the statement with the 2024 Form 1065 filing.
C. Effect of the Election
The Section 754 election permits Ardent Healthcare Intermediate Inc., as the transferee partner that acquired 100% of Pinnacle's membership interests via the reverse merger, to receive a Section 743(b) basis adjustment in the assets of Pinnacle. The adjustment is equal to the difference between the purchase price allocable to Intermediate's interest in Pinnacle and Intermediate's proportionate share of Pinnacle's inside basis (i.e., the tax basis of Pinnacle's assets as reflected on its books). This adjustment is a partner-level adjustment that is personal to Intermediate and does not affect Pinnacle's common basis in its assets.
The computation of the Section 743(b) basis adjustment is set forth in Section IV below.
IV. Section 743(b) Basis Step-Up Computation
A. Computation. The Section 743(b) basis adjustment is computed as follows:
Purchase price allocable to Intermediate's interest in Pinnacle: The entire enterprise value of $412,000,000 is allocable to Intermediate's interest, as Intermediate acquired 100% of Pinnacle's membership interests via the reverse merger. The purchase price for this purpose includes the cash consideration paid to selling members, the fair market value of rollover equity issued to the rollover participants, the funded indebtedness assumed or refinanced at closing, and the transaction expenses borne by the sellers, in each case to the extent such amounts constitute the total consideration paid for Pinnacle's assets in the aggregate.
Pinnacle's aggregate inside basis (tax basis of partnership assets): Based on Pinnacle's balance sheet as of the Closing Date, the aggregate tax basis of Pinnacle's assets is $187,600,000. This figure was confirmed by BSA in the Tax Basis Balance Sheet delivered on May 24, 2024, and reviewed by CPM and Calderwood & Harkness LLP.
Section 743(b) step-up computation:
This $224,400,000 step-up represents the incremental tax basis that Intermediate will receive in Pinnacle's assets over and above Pinnacle's existing common basis. The step-up is allocated among Pinnacle's individual assets in accordance with Section 755 of the Code, as described below.
B. Allocation of Step-Up Among Asset Classes
The Section 743(b) adjustment must be allocated among Pinnacle's assets in accordance with Section 755 of the Code and the applicable Treasury Regulations. Treasury Regulations Section 1.755-1(b) provides that, in the case of a transfer of a partnership interest by sale or exchange, the adjustment is allocated first between two broad classes of assets — ordinary income property and capital gain property — based on the income, gain, or loss that would be allocated to the transferee partner if the partnership were to hypothetically sell all of its assets at fair market value. Within each class, the adjustment is allocated among individual assets based on the relative amounts of income, gain, or loss that would be allocated to the transferee.
For purposes of this memorandum, the allocation has been performed using the residual method consistent with Section 1060 of the Code, applied by analogy. This approach is reflected in the Purchase Price Allocation Schedule dated April 18, 2024, and the Purchase Price Allocation Memorandum of the same date, both of which were prepared by Calderwood & Harkness LLP in consultation with CPM and are incorporated by reference herein. The allocation is summarized as follows:
The Class V intangible assets and their respective allocations and amortization periods are as follows:
(i) Payor contracts: $78,300,000 — amortizable over 15 years under Section 197 of the Code;
(ii) Assembled workforce: $12,100,000 — amortizable over 3 years (note: while assembled workforce is generally subsumed into goodwill for purposes of Section 197, the allocation here reflects the parties' agreed-upon purchase price allocation schedule, and the amortization period has been determined in accordance with the applicable authority);
(iii) Trade name: $38,400,000 — amortizable over 15 years under Section 197;
(iv) Non-compete agreements: $17,400,000 — amortizable over 5 years (the shorter of the stated non-compete period or the 15-year Section 197 amortization period; however, because the non-compete agreements are Section 197 intangibles acquired in connection with the acquisition of a trade or business, the 15-year amortization period applies under Section 197(d)(1)(E), unless a shorter period is available because the non-compete is independently entered into outside the acquisition context — in this case, the 5-year period represents the contractual term of the non-compete, subject to further review in the Post-Closing Tax Integration Memorandum).
The Class VI goodwill allocation of $157,200,000 is amortizable over 15 years under Section 197. Goodwill represents the residual value after allocating the total enterprise value among asset classes I through V.
C. Amortization Benefit
The Section 743(b) step-up of $224,400,000 will generate amortization and depreciation deductions that flow through Pinnacle to Intermediate as Pinnacle's sole member. The estimated annual amortization and depreciation benefit is summarized below:
Weighted-average useful life of stepped-up assets: Approximately 11.2 years, computed as a weighted average of the useful lives of each asset class to which the step-up is allocated, weighted by the dollar amount of step-up allocated to each class.
Estimated annual amortization deduction:
$224,400,000 ÷ 11.2 years = approximately $20,040,000 per year
Estimated annual tax benefit:
$20,040,000 × 25% blended federal/state effective tax rate = approximately $5,010,000 per year
The 25% blended rate reflects the federal corporate income tax rate of 21% plus an estimated weighted-average state and local income tax rate (net of federal benefit) of approximately 4%, based on the apportionment of Pinnacle's income among its operating states (Pennsylvania, Virginia, Maryland, North Carolina, and Georgia). The actual blended rate may vary from year to year depending on changes in state apportionment factors and applicable tax rates.
These amortization deductions flow through Pinnacle to Intermediate as Pinnacle's sole member. Because Intermediate is a C-corporation, the deductions reduce Intermediate's taxable income and, consequently, the corporate income tax payable by Intermediate.
D. Coordination with Tax Receivable Agreement
The tax benefits arising from the Section 743(b) step-up are subject to the Tax Receivable Agreement described in Section XI below. Under the TRA, the TRA Holders are entitled to receive 85% of the realized cash tax savings attributable to the Section 743(b) basis step-up. Accordingly, the estimated annual TRA payment is approximately $4,260,000 (85% × $5,010,000), declining over the amortization period as the stepped-up basis is consumed. See Section XI for further detail on the TRA effective date, administration, and payment mechanics.
V. Section 83(b) Elections for Rollover Participants
A. Background. Each of Dr. Raymond Carvallo (Co-Founder and Chief Executive Officer of Pinnacle), Dr. Nadia Ostrowski (Co-Founder and Chief Medical Officer of Pinnacle), and Jonathan Farnsworth (Chief Financial Officer of Pinnacle) received Class B Units of Ardent Healthcare Holdings LLC in connection with their respective rollover equity contributions at closing. The Class B Units were issued pursuant to the Holdings LLC Agreement and the Management Equity Plan, and represent equity interests in Holdings that are subject to vesting and forfeiture restrictions.
The vesting schedule applicable to the Class B Units is as follows:
(a) 50% of the Class B Units issued to each rollover participant vested immediately upon the Closing Date (May 31, 2024); and
(b) The remaining 50% of the Class B Units vest ratably on a monthly basis over a 36-month period commencing on the Closing Date, subject to the participant's continued employment with Pinnacle (or its affiliates) in the case of Dr. Carvallo and Dr. Ostrowski, and subject to the same continued employment requirement for Mr. Farnsworth.
The unvested Class B Units are structured as profits interests under Revenue Procedure 93-27 and Revenue Procedure 2001-43. As profits interests, the unvested Class B Units are designed to have a liquidation value of zero at the time of grant (i.e., the Class B Units participate only in the appreciation in value of Holdings above a specified threshold, or "hurdle amount," established as of the Closing Date). If properly structured, the receipt of a profits interest by a service provider in exchange for services does not constitute a taxable event at the time of grant. However, because the unvested Class B Units are subject to a substantial risk of forfeiture (the vesting schedule), Section 83 of the Code applies to the transfer, and the rollover participants should file elections under Section 83(b) to ensure favorable tax treatment.
B. Unvested Component Allocation
The unvested component of each rollover participant's Class B Units, representing 50% of the total rollover equity, is as follows:
The unvested component amounts set forth above represent the fair market value of the unvested Class B Units as of the Closing Date based on the rollover equity values established in the Merger Agreement. However, as noted above, to the extent the Class B Units are properly characterized as profits interests with a liquidation value of zero at the time of grant, the amount includible in income under Section 83(b) at the time of the election would be zero (i.e., the election would be made to include zero in gross income with respect to the receipt of the unvested profits interests). The Section 83(b) election is nonetheless critical to preserve favorable tax treatment upon subsequent vesting and disposition, as discussed below.
C. Section 83(b) Election Requirement
Section 83(a) of the Code provides that if property is transferred in connection with the performance of services, and such property is subject to a substantial risk of forfeiture, the excess of the fair market value of the property over the amount paid for the property is includible in the service provider's gross income in the first taxable year in which the property is no longer subject to a substantial risk of forfeiture (i.e., at the time of vesting). However, under Section 83(b), the service provider may elect to include in gross income the excess (if any) of the fair market value of the property at the time of transfer over the amount paid, determined as of the transfer date rather than the vesting date.
For a properly structured profits interest with a liquidation value of zero at the time of grant, the amount includible in income under a Section 83(b) election is zero. The critical benefit of the election is that, once made, any subsequent appreciation in the value of the profits interest is treated as a capital gain upon disposition, rather than as ordinary compensation income recognized at the time of each vesting tranche.
Each rollover participant must file a Section 83(b) election with the Internal Revenue Service within 30 days of the "property transfer date." The property transfer date for each participant is May 31, 2024 — the Closing Date, which is the date on which the Class B Units were issued and transferred to the participants.
Filing deadline: June 30, 2024.
Because June 30, 2024 falls on a Sunday, the filing deadline may extend to Monday, July 1, 2024, under the general rule of Section 7503 of the Code; however, out of an abundance of caution and to avoid any risk of untimely filing, we strongly recommend that each participant file no later than Friday, June 28, 2024.
Template Section 83(b) election forms and transmittal letters were delivered to each rollover participant on May 28, 2024 (in draft form for review) and on May 31, 2024 (in final form, with participant-specific information completed). Each template election form includes the participant's name, address, social security number (redacted in this memorandum), a description of the property transferred (Class B Units of Ardent Healthcare Holdings LLC), the date of transfer (May 31, 2024), the taxable year for which the election is made (2024), the nature of the restrictions on the property (vesting schedule), and the fair market value of the property at the time of transfer and the amount paid for the property.
D. Filing Instructions
Each rollover participant should follow the procedures set forth below to file the Section 83(b) election:
1. File the original election with the IRS. The signed election form and transmittal letter should be mailed via certified mail, return receipt requested to the IRS Service Center where the participant files his or her individual federal income tax return. The use of certified mail provides evidence of timely filing. The election should be mailed sufficiently in advance of the deadline to ensure delivery within the 30-day period.
2. Provide a copy to Ardent Healthcare Holdings LLC. A copy of the filed Section 83(b) election (including the certified mail receipt) should be delivered to Ardent Healthcare Holdings LLC at the following address:
Ardent Healthcare Holdings LLC c/o Ardent Capital Partners III LP 600 Lexington Avenue, 38th Floor New York, NY 10022
Attention: Marcus Pellegrino, Partner, Healthcare
3. Attach a copy to the participant's federal income tax return. A copy of the filed Section 83(b) election must be attached to the participant's timely filed federal income tax return (Form 1040) for the 2024 taxable year. Although the IRS has stated informally that the failure to attach a copy to the income tax return does not invalidate the election if the election was otherwise timely filed, best practice requires attachment.
4. Retain records. Each participant should retain the original certified mail receipt and a copy of the filed election form in his or her permanent tax records.
Critical Action Item: The failure to file a timely Section 83(b) election by June 30, 2024 (or July 1, 2024 at the latest, as discussed above) will result in ordinary income recognition upon the vesting of each tranche of unvested Class B Units, measured as the excess of the fair market value of the vested units at the time of vesting over the amount paid for such units. Given the anticipated appreciation in the value of Holdings' equity, this could result in substantial ordinary income tax liability to the participants. Additionally, the failure to file a timely election cannot be cured retroactively; the IRS does not have authority to grant extensions of the 30-day filing deadline.
E. Responsible Party
Calderwood & Harkness LLP has prepared and delivered the template Section 83(b) election forms and transmittal letters. However, the actual filing of each election is the responsibility of each individual rollover participant and his or her personal tax advisor. Calderwood & Harkness LLP does not serve as personal tax counsel to any of the rollover participants. We have communicated the filing instructions and deadline to Whitford & Gaines LLP (Patricia Engelman, Partner, Tax; Kevin Driscoll, Associate, M&A/Tax), which serves as counsel to the rollover sellers, and have requested that Whitford & Gaines confirm the timely filing of each election.
We recommend that Ardent Capital Partners III LP follow up with each rollover participant and/or Whitford & Gaines LLP promptly after June 30, 2024 to confirm that all Section 83(b) elections have been timely filed.
VI. Rollover Equity Treatment
A. Tax-Deferred Contribution Under Section 721
The contribution of Pinnacle membership interests by each rollover participant to Ardent Healthcare Holdings LLC in exchange for Class B Units of Holdings qualifies as a tax-deferred contribution under Section 721 of the Internal Revenue Code. Section 721(a) provides that no gain or loss is recognized by a partner or a partnership on the contribution of property to a partnership in exchange for a partnership interest. Because Holdings is classified as a partnership for federal income tax purposes, and the rollover participants are contributing appreciated property (their Pinnacle membership interests) to Holdings in exchange for partnership interests (Class B Units), the contribution falls within Section 721(a), and no gain or loss is recognized by the rollover participants upon the contribution.
Calderwood & Harkness LLP delivered a Tax Opinion Letter dated May 29, 2024 (the "Section 721 Tax Opinion") opining that the contribution of Pinnacle membership interests by each rollover participant to Holdings in exchange for Class B Units should qualify as a tax-deferred contribution under Section 721(a) of the Code. The opinion is subject to customary assumptions and qualifications, including the assumption that the contributed Pinnacle membership interests are not "marketable securities" within the meaning of Section 731(c) of the Code (which would give rise to gain recognition on the contribution), that Holdings is properly classified as a partnership for federal income tax purposes, and that the transactions are carried out in accordance with the terms described in the Merger Agreement and related transaction documents.
As a result of the Section 721 treatment, no gain or loss is recognized by any rollover participant upon the contribution of Pinnacle membership interests to Holdings at closing.
B. Rollover Amounts
The following table sets forth the gross equity proceeds, rollover percentage, total rollover amount, and cash-out amount for each rollover participant:
The remaining 27.5% of Pinnacle's pre-closing membership interests were held by 14 minority physician-investors, whose aggregate gross equity proceeds totaled approximately $93,330,000 (all cash, no rollover). Each minority physician-investor received cash merger consideration at closing, less applicable escrow holdbacks and nonresident state withholding, if applicable.
C. Post-Closing Equity Ownership
The rollover participants' combined ownership of post-closing equity in Holdings, calculated on both a pre-dilution and fully diluted basis, is as follows:
Pre-mezzanine warrant dilution:
$59,540,000 ÷ ($198,500,000 + $59,540,000) = $59,540,000 ÷ $258,040,000 = 23.08%
Post-mezzanine warrant dilution (after 2.5% fully diluted equity to Cascadia Mezzanine Fund IV LP):
23.08% × (1 − 2.5%) = 23.08% × 97.5% = 22.50% (fully diluted)
Fund III's post-closing ownership on a fully diluted basis is approximately 75.00% (pre-dilution) and 73.13% (post-mezzanine warrant dilution), with the remaining approximately 2.50% represented by the mezzanine warrants and the management incentive equity pool (the latter of which is allocated out of the Fund III equity).
D. Basis and Holding Period
Each rollover participant's tax basis in the Class B Units received in the rollover equals the participant's adjusted tax basis in the Pinnacle membership interests contributed to Holdings. This is a "substituted basis" under Section 722 of the Code, which provides that a contributing partner's basis in the partnership interest received is equal to the partner's adjusted basis in the contributed property, increased by any gain recognized (if any) on the contribution and decreased by any money received. Because no gain was recognized on the rollover contribution under Section 721(a), and no cash was received in connection with the rollover component (cash-out consideration was received separately in respect of the non-rollover portion), each participant's basis in the Class B Units equals the participant's adjusted basis in the contributed Pinnacle membership interests.
Additionally, each rollover participant's holding period in the Class B Units includes the holding period of the Pinnacle membership interests contributed, pursuant to Section 1223(1) of the Code. This "tacking" of the holding period is significant because it preserves the participants' ability to treat any future gain on disposition of the Class B Units as long-term capital gain (assuming the Pinnacle interests were held for more than one year prior to the contribution, which is the case for all three participants).
VII. Nonresident State Withholding Obligations
A. Withholding Requirements
Several of the states in which Pinnacle operates impose withholding obligations on gains allocable to nonresident individual sellers upon the sale of interests in a partnership or pass-through entity that conducts business in the state. These withholding requirements are designed to ensure that nonresident sellers pay state income tax on the portion of their gain attributable to the partnership's business activities within the state.
We have reviewed the nonresident withholding rules of each state in which Pinnacle has nexus and has determined that withholding obligations arise in Virginia, Maryland, and Georgia. The analysis and computation of the withholding amounts were set forth in the Nonresident Withholding Computation Schedule dated May 15, 2024, which was prepared as a separate Excel workbook and delivered to the parties. A summary of the withholding amounts is provided below.
B. Withholding Amounts by State
These withholding amounts represent the aggregate withholding applicable to all nonresident individual sellers, including Dr. Raymond Carvallo, Dr. Nadia Ostrowski, Jonathan Farnsworth, and the 14 minority physician-investors, to the extent each seller is a nonresident of the applicable state. Sellers who are residents of a particular state are not subject to nonresident withholding by that state but remain responsible for filing individual state income tax returns and paying any applicable state income tax.
C. Computation Methodology
The withholding was computed based on each nonresident individual seller's share of the total gain on the sale of Pinnacle membership interests, apportioned to each state in which Pinnacle has nexus under the applicable state's sourcing and apportionment rules. Pinnacle's apportionment factors were determined based on its 2023 state income tax return filings and, where applicable, adjusted for known changes in Pinnacle's state-by-state business activity through the Closing Date. The Nonresident Withholding Computation Schedule dated May 15, 2024 sets forth the detailed computation for each seller and each state.
D. Remittance Mechanics
The withholding amounts were deducted from the cash merger consideration payable to each nonresident seller at closing. The net cash proceeds disbursed to each nonresident seller on the Closing Date reflect the deduction of the applicable state withholding amounts.
Pinnacle, as the partnership from which the interests were sold, is responsible for remitting the withheld amounts to the applicable state tax authorities within the time periods prescribed by each state's regulations. Pinnacle is also required to furnish nonresident withholding certificates or statements to each seller reflecting the amount withheld, which the sellers may then use as credits against their individual state income tax liabilities.
The filing deadlines for nonresident withholding remittances vary by state but generally fall within 30 to 60 days following the date of the transaction. Specifically:
(a) Virginia: Withholding must be remitted using Form 502W within 30 days of the transaction date. Accordingly, the Virginia remittance is due on or before June 30, 2024.
(b) Maryland: Withholding must be remitted to the Comptroller of Maryland using Form MW506NRS within 60 days of the transaction. The Maryland remittance is due on or before July 30, 2024.
(c) Georgia: Withholding must be remitted to the Georgia Department of Revenue using Form G-2RP (or applicable substitute form) within 30 days of the transaction. The Georgia remittance is due on or before June 30, 2024.
Calderwood & Harkness LLP has coordinated with Caldwell Pratt & Moorehouse LLP (buyer's accountants) and Brewer Stanfield & Associates LLP (target's accountants) to ensure timely remittance and reporting. BSA has primary responsibility for preparing and filing the withholding remittances for the pre-closing period sellers, in coordination with CPM for post-closing administrative support.
E. Pennsylvania and North Carolina
Pennsylvania. Pinnacle operates in Pennsylvania and has nexus in the Commonwealth. However, Pennsylvania does not impose a separate nonresident withholding obligation on the sale of interests in pass-through entities in the manner required by Virginia, Maryland, and Georgia. Nonresident individual sellers who realize gain on the sale of Pinnacle interests apportioned to Pennsylvania remain subject to Pennsylvania personal income tax (currently imposed at a flat rate of 3.07%) on their PA-source gains and are responsible for reporting and paying such tax through their individual Pennsylvania income tax returns (Form PA-40). No closing withholding was required or deducted for Pennsylvania.
North Carolina. North Carolina imposes a withholding requirement on partnerships with respect to nonresident partners' distributive share of income from the partnership. However, with respect to the gain recognized by nonresident sellers upon the sale of their Pinnacle membership interests, our preliminary analysis indicated that North Carolina does not impose a separate closing withholding obligation on the partnership in connection with the sale transaction itself. Rather, the gain should be evaluated under North Carolina's sourcing rules for purposes of the sellers' individual North Carolina income tax returns. The sellers who are nonresidents of North Carolina and who have NC-source gain remain responsible for filing individual North Carolina income tax returns and paying any applicable tax. We recommend that this analysis be confirmed by CPM and BSA in the preparation of the nonresident sellers' state income tax filings.
VIII. Tax Escrow Deposits
A. Tax Indemnity Escrow
A tax indemnity escrow in the amount of $4,120,000 (equal to 1.0% of the enterprise value of $412,000,000) was established at closing to secure the sellers' indemnification obligations for pre-closing tax liabilities under Article IX of the Merger Agreement. The escrow deposit was funded from the sellers' equity proceeds at closing and deposited with Ironbridge Trust Company, N.A. ("Ironbridge"), a national trust company serving as escrow agent.
The key terms of the tax indemnity escrow are as follows:
Escrow Agent: Ironbridge Trust Company, N.A., 1201 North Market Street, Wilmington, Delaware 19801.
Escrow Agreement Reference: ITC-ESC-2024-05312. The Escrow Agreement was executed on May 31, 2024 by the sellers' representative, the buyer (Intermediate), and Ironbridge.
Purpose: The tax indemnity escrow secures the sellers' obligation to indemnify the buyer for any losses arising from (a) breaches of the sellers' tax representations and warranties contained in Article III, Section 3.13 of the Merger Agreement, (b) pre-closing tax liabilities of Pinnacle that were not disclosed in the schedules to the Merger Agreement or reserved for on Pinnacle's balance sheet, and (c) taxes imposed on the sellers or Pinnacle with respect to the pre-closing period (as defined in the Merger Agreement), in each case to the extent such losses exceed any applicable deductible or threshold amount.
Survival Period: The tax indemnity escrow survives for the longer of (a) the expiration of the applicable statute of limitations for the relevant taxable periods (including extensions), plus 60 days, or (b) 36 months following the Closing Date (i.e., until May 31, 2027, at the earliest).
Release Mechanics: Subject to the resolution of any pending claims for indemnification made by the buyer prior to the expiration of the survival period, the remaining balance of the tax indemnity escrow (including any accrued interest or investment earnings thereon) will be released to the sellers (through the sellers' representative) promptly following the expiration of the survival period. Claims may be made against the escrow by delivering a written notice of claim to Ironbridge and the sellers' representative in accordance with the procedures set forth in the Escrow Agreement.
B. General Indemnity Escrow (for Reference)
In addition to the tax indemnity escrow, a general indemnity escrow in the amount of $10,300,000 (equal to 2.5% of the enterprise value of $412,000,000) was established at closing to secure the sellers' indemnification obligations for non-tax representations, warranties, and covenants under the Merger Agreement. The general indemnity escrow is also held by Ironbridge under the same Escrow Agreement (Reference No. ITC-ESC-2024-05312) and is subject to a separate survival period of 18 months following the Closing Date (i.e., until November 30, 2025).
The general indemnity escrow is not within the scope of this tax memorandum and is referenced here solely for completeness in describing the closing funds flow and the total amount of merger consideration withheld from the sellers' proceeds at closing. For a detailed discussion of the general indemnity escrow mechanics, please refer to the Closing Memorandum prepared by Harcourt Shaw & DeVries LLP.
C. R&W Insurance Coordination
In connection with the acquisition, Ardent Healthcare Holdings LLC procured a representations and warranties insurance ("R&W") policy from Continental Indemnity Partners Ltd. The key terms of the R&W policy are as follows:
Insurer: Continental Indemnity Partners Ltd.
Policy Number: CIP-RWI-2024-03821.
Policy Limit: $20,750,000 (approximately 5.0% of enterprise value).
Retention (Deductible): $1,000,000 (approximately 0.24% of enterprise value). The retention is the amount of losses that must be borne by the buyer before the R&W policy responds.
Broker: Bellhaven Risk Advisors LLC.
Coverage: The R&W policy provides coverage for losses arising from breaches of the sellers' representations and warranties in the Merger Agreement, including the tax representations and warranties contained in Article III, Section 3.13.
With respect to tax-related claims, the tax indemnity escrow serves as the primary source of recovery for pre-closing tax liabilities and breaches of tax representations. The R&W policy provides supplementary coverage in excess of the escrow and the retention amount. Specifically, the R&W policy responds to breaches of tax representations and warranties only after the buyer has exhausted the retention amount (which may be satisfied through claims against the tax indemnity escrow or otherwise) and the tax indemnity escrow is insufficient to cover the full amount of the loss.
IX. Form 8308 Filing Obligation
A. Requirement. Section 6050K of the Internal Revenue Code requires a partnership to file Form 8308 (Report of a Sale or Exchange of Certain Partnership Interests) for any calendar year during which there is a sale or exchange of a partnership interest that involves the exchange of "section 751 property" — i.e., unrealized receivables or inventory items as defined in Section 751(c) and (d) of the Code. The Form 8308 serves as an information return that alerts the IRS to the potential recharacterization of a portion of the selling partner's gain as ordinary income (rather than capital gain) to the extent attributable to the partnership's Section 751 assets.
Pinnacle Health Services Group LLC is required to file Form 8308 with its federal partnership income tax return (Form 1065) for the taxable year ending December 31, 2024, because the reverse merger constituted a sale or exchange of all outstanding Pinnacle membership interests, and Pinnacle's assets include Section 751 property (as discussed below).
B. Section 751 Considerations
Pinnacle's assets as of the Closing Date include accounts receivable with a fair market value of approximately $32,400,000 (as reflected in the purchase price allocation). Accounts receivable of a cash-method partnership (and, to the extent they represent unrealized receivables under Section 751(c), accounts receivable of an accrual-method partnership) constitute Section 751(a) "hot assets." Additionally, to the extent any portion of Pinnacle's gain on a hypothetical sale of all assets at fair market value would be attributable to other unrealized receivables (e.g., recapture amounts under Sections 1245 or 1250) or substantially appreciated inventory, such assets also constitute Section 751 property.
The presence of Section 751 assets in Pinnacle's asset portfolio requires the filing of Form 8308 and may result in ordinary income recharacterization for a portion of each selling member's gain on the sale of Pinnacle membership interests. The extent of ordinary income recharacterization for each selling member was addressed in the Purchase Price Allocation Memorandum dated April 18, 2024, and will be reflected on the Schedule K-1 issued to each selling member for the taxable year ending December 31, 2024. Each selling member should consult with his or her personal tax advisor regarding the treatment of the Section 751 ordinary income component on the member's individual income tax return.
C. Filing Responsibility
Pinnacle is the filing party responsible for Form 8308. The form is attached to Pinnacle's Form 1065 for the taxable year ending December 31, 2024, which is due on or before March 15, 2025 (subject to extension). A copy of Form 8308 must be furnished to each selling partner — specifically, Dr. Raymond Carvallo, Dr. Nadia Ostrowski, Jonathan Farnsworth, and each of the 14 minority physician-investors — no later than January 31, 2025 (or, if an extension is obtained, by the extended due date of the partnership return).
Caldwell Pratt & Moorehouse LLP, as the post-closing tax return preparer for Pinnacle, is responsible for the preparation and filing of Form 8308 in coordination with Brewer Stanfield & Associates LLP for pre-closing period information.
X. Purchase Price Allocation Summary
A. Methodology. The purchase price allocation was performed under the residual method prescribed by Section 1060 of the Code and the applicable Treasury Regulations thereunder. Although the transaction is structured as an equity acquisition (the purchase of membership interests in a partnership) rather than a direct asset acquisition, the allocation is performed on an asset-level basis for purposes of the Section 743(b) basis step-up computation under Section 755 of the Code. The residual method requires that the total purchase price be allocated among the acquired assets in order of priority among seven asset classes (Class I through Class VII), with the residual amount allocated to goodwill and going concern value (Class VI/VII).
The allocation was performed by Calderwood & Harkness LLP in consultation with CPM and was reviewed and agreed upon by the buyer and the sellers' representative. The allocation is set forth in the Purchase Price Allocation Schedule dated April 18, 2024, which is attached as Exhibit F to the Merger Agreement.
B. Allocation Schedule (Summary)
Class V Detail:
The purchase price allocation is subject to adjustment following the completion of the post-closing working capital true-up and, if applicable, the payment of earnout consideration in future periods. Any adjustments to the total purchase price resulting from the working capital true-up or earnout payments will be allocated among the asset classes in a manner consistent with the methodology described above.
C. Form 8594 Analysis
Calderwood & Harkness LLP has analyzed whether Form 8594 (Asset Acquisition Statement under Section 1060) is required to be filed in connection with the acquisition. Section 1060(b) requires both the transferor and transferee in an "applicable asset acquisition" to file Form 8594 reporting the allocation of the purchase price among the acquired assets. An "applicable asset acquisition" is defined as any transfer of assets that constitutes a trade or business and to which the purchaser's basis in the assets is determined wholly by reference to the consideration paid.
Because the acquisition was structured as a purchase of membership interests in Pinnacle (a partnership), rather than a direct acquisition of Pinnacle's assets, the transaction does not constitute an "applicable asset acquisition" within the meaning of Section 1060. Accordingly, Calderwood & Harkness LLP has concluded that Form 8594 is not required to be filed by either the buyer or the sellers in connection with this transaction.
Notwithstanding the foregoing, the purchase price allocation schedule is included as Exhibit F to the Merger Agreement and is binding on the buyer and sellers for federal income tax purposes. The allocation is also reflected in the Section 743(b) and Section 755 computations described in Section IV above. Both the buyer and the sellers are obligated under the Merger Agreement to file all tax returns and reports in a manner consistent with the agreed-upon allocation unless otherwise required by a final determination by the IRS or a court of competent jurisdiction.
XI. Tax Receivable Agreement — Effective Date and Administration
A. TRA Effective Date
The Tax Receivable Agreement (the "TRA") was executed in its definitive form on May 28, 2024 and became effective upon the Closing Date, May 31, 2024. The TRA sets forth the terms under which the TRA Holders will receive payments equal to a specified percentage of the realized cash tax savings attributable to the Section 743(b) basis step-up described in Section IV above.
The parties to the TRA are as follows:
(a) Ardent Healthcare Holdings LLC, as the corporate taxpayer (acting through Intermediate as the entity that realizes the tax benefits);
(b) Ardent Healthcare Intermediate Inc., as the direct beneficiary of the partnership-level tax deductions flowing from Pinnacle; and
(c) The TRA Holders, consisting of Dr. Raymond Carvallo, Dr. Nadia Ostrowski, Jonathan Farnsworth, and the 14 pre-closing minority physician-investor members of Pinnacle.
B. TRA Economics
The TRA provides for a sharing percentage of 85% of the realized cash tax savings attributable to the Section 743(b) basis step-up. "Realized cash tax savings" is defined in the TRA as the reduction in the actual cash income tax liability of Intermediate (and, by extension, Holdings) for a given taxable year attributable to the amortization and depreciation deductions arising from the Section 743(b) step-up, as compared to the hypothetical tax liability that would have been payable absent the step-up.
Based on the estimates set forth in Section IV.C above, the annual amortization deduction attributable to the step-up is approximately $20,040,000, generating an estimated annual tax benefit of approximately $5,010,000 at a 25% blended federal/state effective tax rate. The estimated annual TRA payment is therefore:
85% × $5,010,000 = approximately $4,260,000 per year
The TRA payments will decline over the amortization period as the stepped-up basis is consumed. The payments are expected to continue for approximately 15 years (the maximum Section 197 amortization period applicable to the largest components of the step-up), although the actual duration and annual amounts will depend on the timing and amount of actual tax savings realized in each year.
The first TRA payment is expected to be made following the filing and finalization of the first post-closing tax return of Intermediate (for the taxable year ending December 31, 2024). The first-year TRA payment will be pro-rated for the portion of the year from June 1, 2024 through December 31, 2024 (approximately 7 months of a 12-month year), resulting in an estimated first-year payment of approximately:
$4,260,000 × (7/12) = approximately $2,485,000 (subject to final computation)
C. Administration. The TRA provides for the following administrative and governance provisions:
Annual Computation. TRA calculations are to be prepared annually by Caldwell Pratt & Moorehouse LLP, in coordination with Calderwood & Harkness LLP, within 90 days following the filing of Intermediate's federal income tax return for the applicable taxable year. The computation is subject to review and approval by the Board of Managers of Holdings and must be delivered to the TRA Holders' representative within the time period specified in the TRA.
Dispute Resolution. Article VII of the TRA provides for dispute resolution procedures in the event of a disagreement between Holdings and the TRA Holders regarding the computation of realized cash tax savings or the amount of TRA payments. Disputes are initially subject to good faith negotiation, followed by submission to an independent accounting firm for binding determination if the parties are unable to resolve the dispute within 30 days.
Early Termination. The TRA includes early termination provisions that allow Holdings (at its election) or that are triggered upon a change of control of Holdings to terminate the TRA in exchange for a lump-sum early termination payment. The early termination payment is equal to the present value of all remaining TRA obligations, discounted at a rate equal to SOFR plus 100 basis points, and is payable within 90 days following the occurrence of the termination event. The early termination provisions are intended to facilitate a future exit by Fund III without the ongoing burden of TRA payment administration.
XII. FIRPTA Certificates
A. Non-Foreign Status Affidavits
Section 1445 of the Internal Revenue Code imposes a withholding obligation on the transferee (buyer) in a disposition of a "United States real property interest" ("USRPI") by a foreign person. A partnership interest may constitute a USRPI if the partnership holds U.S. real property interests among its assets. To avoid the application of FIRPTA withholding, each seller may furnish to the buyer an affidavit (a "non-foreign status certificate" or "FIRPTA certificate") certifying that the seller is not a foreign person within the meaning of Section 1445 of the Code.