PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION ATTORNEY WORK PRODUCT
MEMORANDUM
June 14, 2024
FROM: Leonard Cross, Partner, Tax, and Robert Jansen, Senior Associate, Tax Calderwood & Harkness LLP One Liberty Plaza, 45th Floor New York, NY 10006
TO: Marcus Pellegrino, Partner, Healthcare Ardent Capital Partners III LP 600 Lexington Avenue, 38th Floor New York, NY 10022
RE: Post-Closing Tax Integration — Acquisition of Pinnacle Health Services Group LLC Matter No. 1001-00006; Engagement No. 1001-00006
COPIES: Claire Ashworth, Co-Founder & Managing Partner, Ardent Capital Partners III LP Dominic Ferrera, Co-Founder & Managing Partner, Ardent Capital Partners III LP Thomas Kundra, Partner, M&A, Harcourt Shaw & DeVries LLP
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I. Purpose and Executive Summary
This memorandum addresses the ongoing post-closing tax compliance obligations, administrative requirements, and planning considerations arising from the closing on May 31, 2024 of Ardent Capital Partners III LP's ("Fund III" or "Ardent") acquisition of 100% of the membership interests in Pinnacle Health Services Group LLC ("Pinnacle" or the "Company," EIN 82-1947632) at an enterprise value of $412 million (equity value: $339.4 million). The transaction closed in accordance with the Agreement and Plan of Merger dated March 15, 2024 (the "Merger Agreement"), as amended by the First Amendment to the Merger Agreement dated May 10, 2024, following the satisfaction of all conditions to closing, including the receipt of required antitrust clearance and state healthcare regulatory approvals.
The transaction was structured as a reverse merger in which Ardent Healthcare Merger Sub LLC, a newly formed Delaware limited liability company and an indirect wholly owned subsidiary of Fund III, merged with and into Pinnacle, with Pinnacle surviving as the continuing entity. The surviving entity is held through a two-tier structure designed to accommodate blocker corporation requirements, facilitate potential future liquidity events, and optimize the tax treatment for all stakeholders. The structural chain is as follows:
• Ardent Healthcare Holdings LLC (EIN 93-2187445, organized under the laws of Delaware, classified as a partnership for federal income tax purposes) serves as the direct investment vehicle through which Fund III and the rollover participants hold their respective economic interests.
• Ardent Healthcare Intermediate Inc. (EIN 93-2187512, incorporated under the laws of Delaware, classified as a C-corporation for federal income tax purposes) functions as a blocker corporation wholly owned by Holdings LLC, designed to block unrelated business taxable income ("UBTI") for tax-exempt limited partners of Fund III, to isolate state tax nexus, and to facilitate a potential future initial public offering.
• Pinnacle Health Services Group LLC (the surviving entity, continuing its pre-existing classification as a partnership for federal income tax purposes) is a wholly owned subsidiary of Intermediate Inc. following the reverse merger of Ardent Healthcare Merger Sub LLC.
This memorandum identifies and addresses the following key post-closing tax workstreams, each of which is discussed in detail in the sections that follow:
1. Tax Receivable Agreement Administration. The TRA executed among Holdings LLC, Intermediate Inc., and the TRA Holders requires annual computation of realized tax benefits, determination of TRA payments, and allocation among the TRA Holders in accordance with their respective pre-closing ownership percentages.
2. Earnout Tax Tracking and Reporting. The Merger Agreement provides for contingent earnout payments of up to $35.0 million over two measurement periods. The tax characterization, Section 483 imputed interest computations, and purchase price adjustment implications require careful tracking and coordination.
3. Section 483 Imputed Interest Computations. Earnout payments deferred beyond one year from the closing date are subject to imputed interest rules under Section 483 of the Internal Revenue Code, requiring present value analysis and bifurcation of payments into principal and interest components.
4. Estimated Tax Payment Scheduling. Intermediate Inc., as a newly formed C-corporation, must compute and remit quarterly estimated federal and state income tax payments. Tax distribution obligations from Holdings LLC to its members must also be coordinated.
5. State Income Tax Return Filing Calendar. Pinnacle operates in five states — Pennsylvania, Virginia, Maryland, North Carolina, and Georgia — each with distinct filing requirements, tax rates, apportionment methods, and estimated payment obligations.
6. Outstanding Elections and Filings. Critical time-sensitive elections and filings remain pending, including Section 83(b) elections for unvested rollover interests (due June 30, 2024), the Section 754 election (to be filed with Pinnacle's 2024 Form 1065), Form 8308, and Schedule K-1 reporting for both the pre-closing and post-closing periods.
7. Coordination with Caldwell Pratt & Moorehouse LLP. Responsibility for ongoing tax compliance preparation transitions from Calderwood & Harkness LLP to Caldwell Pratt & Moorehouse LLP as the buyer's accounting firm, requiring a comprehensive handoff of transaction documents, workpapers, and methodologies.
This memorandum is organized to serve as a practical compliance roadmap for the first 24 months following the closing. Each section identifies specific deadlines, dollar amounts, and responsible parties, and the memorandum concludes with a comprehensive action item checklist that Ardent's deal team may use to track and manage compliance obligations. We recommend that this memorandum be circulated to Caldwell Pratt & Moorehouse LLP promptly following its delivery, so that the accounting team may begin the compliance work described herein within the recommended time frames.
All references to the "Code" are to the Internal Revenue Code of 1986, as amended. All references to "Sections" are to sections of the Code unless otherwise indicated. All references to "Regulations" are to Treasury Regulations promulgated under the Code.
II. Post-Closing Entity and Tax Classification Summary
A. Entity Structure Chart
The following describes the post-closing organizational structure from the top of the investment chain through the operating entity. A complete entity structure chart is provided as Exhibit A to this memorandum.
Ardent Capital Partners III LP (Delaware limited partnership, EIN 87-3491520) is the ultimate investor in the transaction. Fund III committed $198.5 million of equity capital to the acquisition, funded through capital calls on its limited partners in accordance with the Fund III limited partnership agreement. Fund III is managed by its general partner, Ardent Capital GP III LLC (a Delaware limited liability company), which is controlled by Claire Ashworth and Dominic Ferrera as the managing members. Fund III's limited partners include a combination of institutional investors, including pension funds, university endowments, insurance companies, and fund-of-funds vehicles, certain of which are tax-exempt entities under Section 501(c)(3) of the Code.
Rollover Participants. Three members of Pinnacle's pre-closing management team elected to roll over a portion of their pre-closing equity into Class B Units of Ardent Healthcare Holdings LLC in lieu of receiving full cash consideration at closing. The rollover participants and their respective rollover amounts are as follows:
The total rollover of $59.54 million represents 23.08% of post-closing equity in Holdings LLC on a pre-dilution basis, and 22.50% on a fully diluted basis after giving effect to the 2.5% equity warrants issued to Cascadia Mezzanine Fund IV LP in connection with the mezzanine financing.
Cascadia Mezzanine Fund IV LP holds warrants to acquire equity interests in Holdings LLC representing 2.5% of fully diluted equity. The warrants were issued as an equity kicker in connection with the $30 million mezzanine facility provided by Cascadia Mezzanine Fund IV LP (discussed in greater detail in Section X.B below).
Ardent Healthcare Holdings LLC (EIN 93-2187445, organized under the laws of Delaware) serves as the holding company through which Fund III (via its Class A Units) and the rollover participants (via their Class B Units) hold their economic interests. Holdings LLC is classified as a partnership for federal income tax purposes. No Form 8832 (Entity Classification Election) has been filed, and the entity's default classification as a multi-member limited liability company treated as a partnership applies. Holdings LLC's Amended and Restated Limited Liability Company Agreement, dated May 31, 2024 (the "Holdings LLC Agreement"), governs the economic and governance rights of the members, including distribution waterfall provisions, tax distribution requirements, and management fee arrangements.
Ardent Healthcare Intermediate Inc. (EIN 93-2187512, incorporated under the laws of Delaware) is a C-corporation wholly owned by Holdings LLC. Intermediate Inc. serves as a blocker entity interposed between Holdings LLC and Pinnacle for the following principal tax purposes: (i) to block UBTI that would otherwise flow through to tax-exempt limited partners of Fund III if Pinnacle's operating income were allocated directly to them through a pass-through chain; (ii) to isolate state income tax nexus at the corporate level, thereby simplifying the state filing obligations of Fund III and its individual limited partners; and (iii) to facilitate a potential future initial public offering, which would be structurally simpler with a corporate issuer. Intermediate Inc. has adopted a calendar year for federal income tax purposes.
Pinnacle Health Services Group LLC (EIN 82-1947632, organized under the laws of Delaware) is the surviving operating entity. Pinnacle was originally organized on August 12, 2016 and has been classified as a partnership for federal income tax purposes since its formation. The reverse merger of Ardent Healthcare Merger Sub LLC with and into Pinnacle did not change Pinnacle's tax classification; Pinnacle continues to be treated as a partnership for federal income tax purposes. Following the merger, Intermediate Inc. is the sole member of Pinnacle. Pinnacle's amended and restated limited liability company operating agreement (as amended at closing) governs its operations. A Section 754 election is pending and will be filed with Pinnacle's 2024 partnership tax return (Form 1065) for the taxable year ending December 31, 2024, as discussed in Section III.B below.
B. Tax Classification Confirmations
For the avoidance of doubt, the federal income tax classification of each entity in the post-closing structure is as follows:
We note that no entity reclassification actions are contemplated or should be undertaken without prior consultation with tax counsel. Any change in the tax classification of Holdings LLC (e.g., an election to be treated as a corporation) or Pinnacle (e.g., conversion to a disregarded entity if Intermediate Inc. remains the sole member and a check-the-box election is filed) could trigger significant and potentially adverse tax consequences, including deemed taxable dispositions of assets and termination of favorable tax attributes. Any such action should be analyzed in connection with a comprehensive exit planning engagement.
III. Outstanding Elections and Filing Deadlines
A. Section 83(b) Elections
1. Applicability. Section 83(b) elections are applicable to the unvested Class B Units of Ardent Healthcare Holdings LLC received by the three rollover participants in connection with the closing. Each rollover participant received Class B Units in exchange for the rollover of a portion of their pre-closing Pinnacle membership interests. A portion of each participant's Class B Units vested immediately at closing, while the remaining units are subject to time-based vesting conditions as set forth in the Holdings LLC Agreement and the individual Restricted Unit Award Agreements executed at closing.
The unvested Class B Units are structured as profits interests within the meaning of Revenue Procedure 93-27, 1993-2 C.B. 343, and Revenue Procedure 2001-43, 2001-2 C.B. 191. The unvested units have a liquidation value of zero at the time of grant (based on a participation threshold equal to the fair market value of Holdings LLC at closing), such that the units will only have value to the extent of appreciation in Holdings LLC's value above the closing-date threshold. This characterization is supported by the valuation analysis performed by Harcourt Shaw & DeVries LLP and confirmed by Calderwood & Harkness's independent review.
2. Vesting Schedule and Unvested Amounts
The vesting terms for each rollover participant are as follows:
For Dr. Carvallo and Dr. Ostrowski, the unvested 50% vests ratably over 36 months, subject to continued employment with Pinnacle in their respective capacities as Chief Executive Officer and Chief Medical Officer. Mr. Farnsworth's unvested units vest on a similar 36-month ratable schedule, subject to continued employment as Chief Financial Officer.
3. Filing Deadline and Procedures
The deadline for filing a Section 83(b) election is 30 days from the date of the transfer of the property subject to the election. The transfer date for purposes of Section 83(b) is the closing date: May 31, 2024. Accordingly, the filing deadline is June 30, 2024.
Template Section 83(b) election forms and accompanying transmittal letters were prepared by Calderwood & Harkness and delivered to each rollover participant on May 28, 2024, prior to the closing. Each participant was instructed to:
(a) Execute two copies of the election form;
(b) Mail one copy to the Internal Revenue Service Center at which the participant files his or her individual income tax return, via United States Postal Service certified mail, return receipt requested;
(c) Retain the second copy, along with the certified mail receipt, for the participant's personal records;
(d) Attach a copy of the election to the participant's federal income tax return for the taxable year in which the transfer occurred (i.e., the participant's 2024 individual income tax return); and
(e) Deliver a copy of the filed election to Ardent Healthcare Holdings LLC (attention: Marcus Pellegrino) for the entity's records.
4. Action Item
Action Required: Confirm that each participant has filed (or is on track to file) the Section 83(b) election no later than June 28, 2024 (allowing two business days for postal delivery prior to the June 30 deadline). Retain copies of the filed elections, certified mail receipts, and evidence of timely filing.
Responsible Party: Leonard Cross / Robert Jansen (Calderwood & Harkness LLP), in coordination with each participant and their personal tax advisors.
5. Consequences of Failure to File
Failure to timely file a Section 83(b) election would result in the following adverse consequences for each affected participant:
(a) The participant would be required to recognize ordinary income upon each vesting date, measured by the fair market value of the vested units at the time of vesting less any amount paid for the units. Given the expected appreciation of Holdings LLC over the 36-month vesting period, the aggregate ordinary income recognized could be substantial.
(b) Holdings LLC would have withholding and reporting obligations with respect to the ordinary income recognized by the participant, including the obligation to report such income on Form W-2 (if the participant is treated as an employee for this purpose) or on Schedule K-1 (if the participant is treated as a partner receiving a guaranteed payment).
(c) The participant's holding period for long-term capital gains purposes would not begin until the applicable vesting date, potentially converting what would otherwise be long-term capital gain on a future disposition into short-term capital gain or ordinary income.
We consider the timely filing of the Section 83(b) elections to be the single most time-sensitive post-closing tax item and recommend that Ardent's deal team confirm compliance before all other action items.
B. Section 754 Election
1. Overview. Section 754 of the Code permits a partnership to elect to adjust the basis of its assets with respect to a transferee partner under Section 743(b). Once made, the election is irrevocable and applies to all future transfers of partnership interests unless the Internal Revenue Service grants a revocation under Regulations Section 1.754-1(c).
Pinnacle will file a Section 754 election with its 2024 partnership tax return (Form 1065) for the taxable year ending December 31, 2024. The election is critical to the transaction structure because it permits Intermediate Inc. (as the transferee partner acquiring 100% of the Pinnacle membership interests) to obtain a basis adjustment under Section 743(b) equal to the difference between the purchase price for the interests and Pinnacle's inside basis in its assets. As detailed in Section IV below, this adjustment is approximately $224.4 million and will generate significant amortization deductions over the weighted-average useful life of the underlying assets.
2. Status of Election
A draft Section 754 election statement was prepared by Calderwood & Harkness and delivered to the parties on May 31, 2024. The election statement complies with the requirements of Regulations Section 1.754-1(b) and includes the name and address of the partnership, a declaration that the partnership elects under Section 754 to apply the provisions of Section 734(b) and Section 743(b), and the signature of an authorized partner.
3. Coordination and Filing
Caldwell Pratt & Moorehouse LLP will be responsible for preparing Pinnacle's 2024 Form 1065, to which the Section 754 election statement must be attached. The Form 1065 is due on March 15, 2025 (for a calendar-year partnership), with an automatic six-month extension available through September 15, 2025, upon timely filing of Form 7004. We recommend that the Form 1065 be filed (or that a valid extension be obtained) by March 15, 2025 to ensure that the election is timely made.
4. Authorization. The election must be signed by a partner authorized to make elections on behalf of the partnership. We recommend confirming that the Pinnacle LLC operating agreement (originally dated August 12, 2016, as amended March 3, 2020, and as further amended and restated at closing on May 31, 2024) designates the appropriate person — which, post-closing, should be the sole member (Intermediate Inc.) or its authorized representative — as the person empowered to sign partnership elections. If the operating agreement does not clearly designate this authority, a board resolution or written consent of Intermediate Inc. authorizing the signing party should be obtained and retained in the file.
C. Form 8308 — Report of Partnership Interest Exchange
Section 6050K of the Code requires a partnership to file Form 8308 (Report of a Sale or Exchange of Certain Partnership Interests) if a partner exchanges a partnership interest and any portion of the money or other property received in exchange is attributable to unrealized receivables or inventory items (as defined in Section 751). Given the nature of Pinnacle's assets — which include accounts receivable, supplies inventory, and intangible assets that may constitute unrealized receivables within the meaning of Section 751(c) — Form 8308 is required to be filed for the taxable year that includes the closing date (2024).
Form 8308 must be filed as an attachment to Pinnacle's 2024 Form 1065. It must report the exchange of partnership interests by all pre-closing members of Pinnacle, including the names, addresses, and taxpayer identification numbers of each exchanging partner. Caldwell Pratt & Moorehouse LLP will be responsible for preparing Form 8308, and Calderwood & Harkness will review the form prior to filing for accuracy and completeness.
In addition, Pinnacle is required to furnish a copy of the Form 8308 information to each selling member (or their representative) on or before the date the form is filed.
D. Form 8594 — Asset Acquisition Statement
Section 1060 of the Code requires both the buyer and seller in an "applicable asset acquisition" to file Form 8594 (Asset Acquisition Statement Under Section 1060) with their respective income tax returns for the taxable year in which the acquisition occurs. An applicable asset acquisition is defined as a transfer of assets that constitutes a trade or business in which the transferee's basis in the assets is determined wholly by reference to the consideration paid.
Following analysis of the transaction structure, we have concluded that Form 8594 is not required in connection with this acquisition. The transaction was structured as an acquisition of membership interests in Pinnacle (i.e., an interest-level transaction), not as a direct acquisition of Pinnacle's assets. Accordingly, the transaction does not constitute an applicable asset acquisition under Section 1060. The Section 743(b) basis adjustment arises under the partnership tax rules (by reason of the Section 754 election), not under Section 1060.
Notwithstanding the inapplicability of Form 8594, the parties have agreed upon a purchase price allocation schedule, which is attached as an exhibit to the Merger Agreement dated March 15, 2024. This allocation is reflected in the Section 743(b) basis step-up computation discussed in Section IV below. Both buyer and seller should maintain consistent allocation positions on their respective returns to minimize the risk of an IRS challenge.
E. Schedule K-1 Reporting
Pinnacle's 2024 Form 1065 will cover the full calendar year from January 1, 2024 through December 31, 2024. However, because the ownership of Pinnacle changed on May 31, 2024, the income, deductions, gains, losses, and credits of Pinnacle must be allocated between the pre-closing members and the post-closing sole member (Intermediate Inc.) in accordance with the interim closing of the books method (or such other method as is specified in the Merger Agreement and permitted under Section 706(d)).
Pre-Closing Period (January 1 – May 31, 2024): Pinnacle must issue Schedules K-1 to all pre-closing members reflecting their allocable shares of Pinnacle's items for the short period ending May 31, 2024. The pre-closing members include Dr. Raymond Carvallo, Dr. Nadia Ostrowski, Jonathan Farnsworth, and the 14 minority physician-investors. Preparation of the pre-closing short-period K-1s will be coordinated with Brewer Stanfield & Associates LLP (the target's accountants, based in Philadelphia, PA), which has historical familiarity with Pinnacle's books and records.
Post-Closing Period (June 1 – December 31, 2024): A separate Schedule K-1 will be issued to Intermediate Inc. as the sole member of Pinnacle for the post-closing period. This K-1 will reflect all items of income, deduction, gain, loss, and credit allocable to Intermediate Inc. for the seven-month period following the closing, including the Section 743(b) amortization deductions. Caldwell Pratt & Moorehouse LLP will prepare the post-closing K-1.
It is critical that the interim closing of the books method be applied consistently and that the books of Pinnacle be properly closed as of the closing date. The Merger Agreement specifies the interim closing method as the required allocation methodology, and this approach should be confirmed with Caldwell Pratt & Moorehouse LLP as part of the document handoff process.
IV. Section 743(b) Basis Step-Up Administration
A. Computation of Basis Adjustment
Section 743(b) of the Code provides that, in the case of a transfer of a partnership interest with respect to which a Section 754 election is in effect, the partnership shall adjust the basis of its assets with respect to the transferee partner. The adjustment is equal to the difference between the transferee partner's outside basis in its partnership interest (generally, the purchase price) and the transferee partner's share of the partnership's inside basis in its assets.
In this transaction, the Section 743(b) basis adjustment is computed as follows:
Purchase price (enterprise value): $412.0 million
Less: Pinnacle's aggregate inside basis in its assets: ($187.6 million)
Section 743(b) basis step-up: $224.4 million
The $224.4 million basis step-up is allocated among Pinnacle's assets in accordance with the purchase price allocation schedule dated April 18, 2024, which was prepared by Caldwell Pratt & Moorehouse LLP in consultation with Calderwood & Harkness and agreed upon by the parties. The allocation follows the residual method prescribed by Section 1060 (applied by analogy in the Section 743(b) context) and allocates the total purchase price across seven asset classes as follows:
The Class V intangible assets are further allocated as follows:
A detailed asset-by-asset amortization schedule is provided as Exhibit B to this memorandum.
B. Amortization Computation
Based on the purchase price allocation described above, the annual amortization deduction attributable to the Section 743(b) basis step-up is computed as follows:
Weighted-average useful life: Approximately 11.2 years (weighted by the dollar amount allocated to each asset class and its respective useful life)
Annual amortization deduction: $224.4 million ÷ 11.2 years ≈ $20.04 million per year
Annual tax benefit at blended federal/state rate of 25%: $20.04 million × 25% = approximately $5.01 million per year
We note that the annual amortization deduction is not constant across all years. The front-loaded amortization from the shorter-lived assets (assembled workforce at 3 years, non-compete agreements at 5 years) will result in higher deductions in the first three to five years, declining as those assets are fully amortized. For purposes of TRA computations and tax planning, we recommend that Caldwell Pratt & Moorehouse LLP maintain a year-by-year amortization schedule by asset class that reflects the actual annual deduction rather than the straight-line average.
The amortization deduction flows through the following chain:
1. The Section 743(b) basis adjustment is reflected on Pinnacle's partnership return (Form 1065), but as a special basis adjustment applicable only to Intermediate Inc.;
2. The amortization deduction attributable to the Section 743(b) adjustment is reported on Intermediate Inc.'s Schedule K-1 from Pinnacle;
3. Intermediate Inc. claims the amortization deduction on its corporate income tax return (Form 1120), reducing its federal and state income tax liability.
C. Ongoing Tracking Requirements
The following ongoing tracking requirements apply to the Section 743(b) basis adjustment:
Separate Basis Schedule. A separate Section 743(b) basis adjustment schedule must be maintained for Intermediate Inc. The adjustment is specific to Intermediate Inc. as the transferee partner and is tracked independently from Pinnacle's common inside basis. This means that Pinnacle's Form 1065 will reflect two sets of basis computations: (i) the common inside basis applicable to Pinnacle generally, and (ii) the special basis adjustment applicable solely to Intermediate Inc.
Subsequent Acquisitions. If any rollover participant exits their investment (e.g., through a repurchase of Class B Units by Holdings LLC, or through a secondary sale), and if the exit results in an indirect transfer of Pinnacle membership interests (flowing down through the structural chain), additional Section 743(b) computations may be required. The specific treatment will depend on whether the transfer is characterized as an interest-level transfer at the Holdings LLC level or at the Pinnacle level and on the applicable step transaction analysis.
Asset Dispositions. If Pinnacle disposes of any assets to which a Section 743(b) basis adjustment has been allocated, the adjustment with respect to that asset is eliminated, and any gain or loss on the disposition is computed taking into account the adjusted basis (common basis plus the Section 743(b) adjustment) for Intermediate Inc.
Annual Review. Caldwell Pratt & Moorehouse LLP is responsible for maintaining the detailed Section 743(b) schedules. Calderwood & Harkness recommends an annual review of these schedules to confirm accuracy, particularly in the first three years when the shorter-lived assets are being amortized and any earnout payments may require purchase price adjustments.
V. Tax Receivable Agreement Administration
A. Overview of TRA Terms
The Tax Receivable Agreement (the "TRA") was executed on May 28, 2024 among Ardent Healthcare Holdings LLC, Ardent Healthcare Intermediate Inc., and the following TRA Holders: Dr. Raymond Carvallo, Dr. Nadia Ostrowski, Jonathan Farnsworth, and the 14 minority pre-closing physician-investors of Pinnacle (collectively, the "TRA Holders"). The TRA was negotiated as part of the overall transaction consideration and was a condition to the sellers' agreement to consummate the merger.
Under the TRA, Holdings LLC and Intermediate Inc. have agreed to pay to the TRA Holders 85% of the realized tax benefits attributable to the Section 743(b) basis step-up arising from the acquisition. The remaining 15% of the tax benefit is retained by Intermediate Inc. (and, economically, by Holdings LLC and its members, including Fund III).
Based on the estimated annual tax benefit of approximately $5.01 million (as computed in Section IV.B above), the estimated annual TRA payment is approximately $4.26 million per year (85% × $5.01 million), declining over the amortization period as the basis step-up is consumed through amortization deductions. The TRA payment will also decline in years where shorter-lived assets have been fully amortized, reducing the annual amortization deduction.
The TRA has a term coextensive with the amortization period for the longest-lived assets subject to the basis step-up (i.e., 15 years for Section 197 intangibles), subject to early termination as described in Section V.D below.
B. Annual Payment Computation Mechanics
The TRA specifies the following methodology for computing the annual TRA payment:
Step 1 — Compute Actual Tax Benefit. Caldwell Pratt & Moorehouse LLP will compute the actual tax benefit realized by Intermediate Inc. (or the consolidated group, if applicable) from the Section 743(b) amortization deductions claimed on Intermediate Inc.'s federal and state income tax returns for the relevant taxable year.
Step 2 — "With and Without" Comparison. The tax benefit is determined by performing a "with and without" computation — that is, computing Intermediate Inc.'s total federal and state income tax liability both (a) with the Section 743(b) amortization deductions and (b) without the Section 743(b) amortization deductions. The difference between these two amounts constitutes the "realized tax benefit" for the year.
Step 3 — Apply Sharing Percentage. The realized tax benefit is multiplied by 85% to determine the total TRA payment for the year.
Step 4 — Timing of Payment. The TRA payment is due within 90 days (or such other period as specified in the TRA) after the later of (a) the filing of the relevant income tax return (federal or state, as applicable) reflecting the Section 743(b) amortization deductions or (b) the final determination of the tax benefit amount (e.g., following the resolution of any audit or amended return adjustment).
The "with and without" methodology is the standard approach for TRA computations in private equity transactions and is designed to measure the actual, incremental tax savings attributable to the basis step-up. Calderwood & Harkness is available to review the annual "with and without" computation prepared by Caldwell Pratt & Moorehouse LLP and to assist in resolving any methodological disputes that may arise between the TRA Holders and the paying parties.
C. Allocation Among TRA Holders
TRA payments are allocated pro rata among the TRA Holders based on their respective pre-closing ownership percentages in Pinnacle, as set forth in the TRA:
The individual allocation among the 14 minority physician-investors is further specified in Schedule A to the TRA, which we have reviewed and confirmed to be mathematically consistent with the aggregate 27.5% allocation.
D. Early Termination and Change of Control Provisions
The TRA contains the following material provisions relating to early termination and change of control:
Voluntary Early Termination. Holdings LLC (or its affiliates) may elect to terminate the TRA early at any time. Upon a voluntary early termination, Holdings LLC is required to make a lump-sum early termination payment to the TRA Holders equal to the net present value of all remaining projected TRA payments over the remaining term of the agreement. The discount rate for purposes of the NPV computation is specified in the TRA as SOFR plus 150 basis points, measured as of the date of the termination election.
Change of Control. A "change of control" of Holdings LLC (as defined in the TRA, which includes any merger, sale of all or substantially all assets, or change in majority voting control) triggers an automatic early termination of the TRA and acceleration of the early termination payment. The change of control provision ensures that the TRA Holders are "made whole" in the event of a sale or IPO of the business, regardless of whether the acquirer or successor entity would continue to realize the tax benefits.
Coordination with Earnout Acceleration. The Merger Agreement provides for 100% payout of any unpaid earnout upon a change of control of Holdings LLC during the earnout period (June 1, 2024 through May 31, 2026). In the event of a change of control, both the TRA early termination payment and the earnout acceleration payment would become due simultaneously. We recommend that Ardent's deal team model the aggregate cash outflow that would result from a change of control during the earnout period, including both the TRA early termination payment (estimated at $40–$50 million in present value terms, depending on discount rate and timing) and the full earnout payment (up to $35.0 million), to understand the total financial exposure.
E. Administrative Recommendations
To ensure the efficient and accurate administration of the TRA, we recommend the following:
1. Designate a TRA Administrator. Ardent should designate an internal point of contact (or engage an external administrator) to manage the annual TRA computation, notice, and payment process. The TRA administrator should coordinate with Caldwell Pratt & Moorehouse LLP on the annual "with and without" computation and with Calderwood & Harkness (or successor tax counsel) on any methodological or interpretive questions.
2. Maintain Detailed Records. Comprehensive records of all Section 743(b) amortization deductions must be maintained on a year-by-year and asset-class-by-asset-class basis. These records should be maintained in a format that facilitates the annual "with and without" computation and the allocation of TRA payments among the TRA Holders.
3. Annual Reporting Package. The TRA administrator should prepare and deliver an annual reporting package to each TRA Holder that includes: (a) the amortization schedule for the relevant year; (b) the "with and without" tax benefit computation; (c) the total TRA payment amount; and (d) the individual allocation to each TRA Holder. The TRA specifies a notice and review period during which the TRA Holders may review the computation and raise objections; the TRA administrator should track these notice periods carefully.
4. Coordination with Earnout and 743(b) Adjustments. As discussed in Section VI below, earnout payments, when made, increase the purchase price and correspondingly increase the Section 743(b) basis step-up. This results in incremental amortization deductions and incremental TRA payments. The TRA administrator should ensure that the 743(b) amortization schedules are updated each time an earnout payment is made and that the TRA computations reflect the updated schedules.
VI. Earnout Tax Tracking and Reporting
A. Earnout Structure Summary
The Merger Agreement provides for contingent earnout payments to the pre-closing members of Pinnacle, structured in two measurement periods as follows:
The earnout EBITDA targets are measured on a trailing twelve-month basis as of the end of each measurement period, using the definition of "EBITDA" set forth in Section 2.4(b) of the Merger Agreement. The EBITDA definition is based on GAAP with specified adjustments, including add-backs for management fees, transaction-related expenses, non-recurring restructuring charges, and non-cash stock-based compensation.
If the applicable EBITDA target is met or exceeded, the full payout amount for that period is earned. There are no partial payouts or interpolations between threshold and target levels; each period is binary — either the full payout is earned or no payout is due.
Earnout Acceleration. In the event of a change of control of Ardent Healthcare Holdings LLC during the earnout period (on or before May 31, 2026), 100% of any unpaid earnout — including any period not yet completed — is accelerated and payable in full at the closing of the change-of-control transaction. This provision is designed to protect the sellers against the risk that a subsequent acquirer would manipulate Pinnacle's financial performance or accounting to avoid triggering the earnout targets.
B. Tax Characterization
The tax characterization of the earnout payments was analyzed in detail in the Earnout Tax Characterization Memorandum dated March 1, 2024, prepared by Calderwood & Harkness (a copy of which has been provided to all parties and to Caldwell Pratt & Moorehouse LLP). The key conclusions of that memorandum are summarized below.
Classification as Additional Purchase Price. The earnout payments are properly treated as additional purchase price for the Pinnacle membership interests, resulting in capital gain to the sellers and an increase in the buyer's cost basis. The payments are not classified as compensation for services or as payments subject to employment tax withholding. This characterization is supported by the following structuring safeguards embedded in the Merger Agreement:
(a) The earnout payments are allocated pro rata among all pre-closing Pinnacle members (including the rollover participants with respect to their cashed-out portions), in proportion to their pre-closing ownership percentages. This pro rata allocation is inconsistent with a compensation characterization, which would require payments to be linked to specific individuals' employment relationships.
(b) There is no employment condition or forfeiture-for-termination language in the earnout provisions. The sellers are entitled to their share of the earnout regardless of whether they remain employed by Pinnacle during the measurement period.
(c) The earnout is clearly delineated from the separate non-compete agreements ($17.4 million, allocated to specific individuals and amortized over 5 years) and consulting arrangements entered into by Dr. Carvallo and Dr. Ostrowski at closing. The non-compete and consulting payments are reported as ordinary income to the recipients and deducted by the buyer, consistent with their compensatory character.
(d) The earnout targets are based on enterprise-level financial performance (EBITDA of the entire Pinnacle business), not on individual performance metrics.
Buyer's Treatment. From the buyer's perspective, earnout payments when made constitute additional purchase price, increasing the total consideration paid for the Pinnacle membership interests. This increase in purchase price correspondingly increases the Section 743(b) basis step-up allocated to Pinnacle's assets, requiring updated amortization schedules and, consequently, updated TRA payment computations. The incremental 743(b) adjustment resulting from each earnout payment will be allocated across Pinnacle's asset classes using the same proportional allocation as the original purchase price allocation (unless circumstances at the time of the earnout payment warrant a revised allocation).
C. Section 483 Imputed Interest
1. Applicability. Section 483 of the Code applies to payments for the sale or exchange of property where some or all of the payments are due more than one year after the date of the sale or exchange, and the payments do not provide for adequate stated interest. The earnout payments in this transaction are contingent in both amount and timing, but if earned, they will be paid more than one year after the closing date. Accordingly, Section 483 applies to each earnout payment, and a portion of each payment will be recharacterized as imputed interest.
2. Computation.
Period 1 Payout ($15.0 million, if earned). This payout is due after May 31, 2025, which is more than one year after the closing date of May 31, 2024. Accordingly, the Period 1 payout exceeds the one-year deferral threshold and is subject to Section 483 imputed interest.
Period 2 Payout ($20.0 million, if earned). This payout is due after May 31, 2026, which is more than two years after the closing date. The Period 2 payout is also subject to Section 483 imputed interest, and the imputed interest component will be larger than for the Period 1 payout due to the longer deferral period.
The applicable federal rates ("AFRs") at the time of signing the Merger Agreement (March 15, 2024) are as follows:
The present value of each earnout payment must be computed using the applicable AFR (semiannual compounding) to determine the "total unstated interest" — the difference between the nominal amount of the earnout payment and its present value as of the closing date. The imputed interest component is then allocated over the deferral period using the constant-yield method.
3. Tax Treatment
Imputed interest is ordinary income to the recipient and is reportable as interest income on the recipient's individual income tax return for the taxable year in which it accrues or is received (depending on the recipient's method of accounting).
Imputed interest is deductible by the buyer (subject to potential limitations under Section 163(j), discussed in Section X.B below) or, alternatively, may be capitalized as part of the acquisition cost. The treatment on the buyer's side should be coordinated with Caldwell Pratt & Moorehouse LLP to ensure consistency with the overall purchase price adjustment methodology.
Caldwell Pratt & Moorehouse LLP will compute the imputed interest at the time of each earnout payment, and Calderwood & Harkness is available to review the computations for accuracy and compliance with Section 483.
D. Reporting Obligations
The following reporting obligations arise in connection with the earnout payments:
Buyer Reporting. The buyer (Intermediate Inc.) must report the imputed interest component as a deduction (or capitalize it as part of the acquisition cost, depending on the elected treatment). In addition, the buyer must adjust the purchase price allocation to reflect the additional consideration paid when each earnout payment is made, and must update the Section 743(b) amortization schedules accordingly.
Seller Reporting. Each selling member must report the capital gain component and the ordinary income (imputed interest) component of the earnout payment separately on their individual income tax returns. The capital gain component should be reported on Schedule D (Capital Gains and Losses), while the imputed interest component should be reported on Schedule B (Interest and Ordinary Dividends) or as other interest income.
Information Reporting. Forms 1099-INT and/or 1099-B may be required for earnout payments made to individual sellers. Caldwell Pratt & Moorehouse LLP should confirm the applicability and prepare the required information returns. Forms 1099 must generally be furnished to the recipient by January 31 of the year following the year of payment and filed with the IRS by February 28 (or March 31, if filed electronically).
Updated Section 743(b) Schedules. Each time an earnout payment is made, the Section 743(b) basis step-up must be recomputed to reflect the increase in purchase price. Updated amortization schedules must be prepared and provided to the TRA administrator for recalculation of TRA payments.
E. Earnout EBITDA Tracking — Tax Coordination
The EBITDA definition used for earnout measurement purposes is contractually defined in the Merger Agreement and may differ from taxable income computed for federal and state income tax purposes. Differences may arise from, among other things, GAAP-to-tax adjustments, timing differences in revenue and expense recognition, and specified add-backs and exclusions in the contractual EBITDA definition.
We recommend that Ardent's internal finance team perform quarterly internal tracking of Pinnacle's financial performance against the earnout EBITDA targets. This tracking will serve two purposes: (i) it will allow Ardent to assess the probability of each earnout payment being triggered, which is relevant for financial reporting and reserve purposes; and (ii) it will facilitate tax planning, including the computation of estimated tax payments (which should be adjusted to reflect the anticipated imputed interest accrual) and the accrual of contingent purchase price adjustments.
Any divergence between the contractual EBITDA definition and tax accounting income should be identified and reconciled on a quarterly basis, with input from Caldwell Pratt & Moorehouse LLP.
VII. Estimated Tax Payment Schedule
A. Ardent Healthcare Holdings LLC (Partnership)
As a partnership for federal income tax purposes, Holdings LLC is not itself subject to federal income tax. Rather, each item of income, deduction, gain, loss, and credit is allocated to Holdings LLC's members (Fund III and the rollover participants) in accordance with the Holdings LLC Agreement, and each member reports its allocable share on its own tax return.
However, Holdings LLC is required under the Holdings LLC Agreement to make tax distributions to its members in amounts sufficient to cover each member's estimated tax liability on income allocated from Holdings LLC. The tax distribution provisions are set forth in the Holdings LLC Agreement and are computed based on Section 704(b) capital account provisions and a tax distribution waterfall that ensures priority distributions to all members for estimated tax obligations before other distributions.
The estimated tax distribution dates should be aligned with the quarterly estimated tax payment deadlines applicable to Holdings LLC's members:
• April 15 (first quarter estimated payment)
• June 15 (second quarter estimated payment)
• September 15 (third quarter estimated payment)
• January 15 of the following year (fourth quarter estimated payment)
New York Nexus Considerations. Holdings LLC's management activities are directed from Ardent Capital's offices at 600 Lexington Avenue, New York, NY. New York nexus has been mitigated by routing management fee agreements between Ardent Capital GP III LLC (which is already nexused in New York by reason of its principal office location and management activities) and Intermediate Inc. This routing ensures that management fees are paid at the Intermediate Inc. level (a C-corporation with defined state tax nexus) rather than at the Holdings LLC level. Holdings LLC should not directly enter into management service agreements with Pinnacle or Intermediate Inc., as doing so could create direct New York nexus for Holdings LLC and, by extension, for its individual members (including the rollover participants who reside outside New York).
B. Ardent Healthcare Intermediate Inc. (C-Corporation)
Intermediate Inc. is subject to federal corporate income tax and will file Form 1120 (U.S. Corporation Income Tax Return) for each taxable year. Intermediate Inc. has adopted a calendar year for federal income tax purposes. We recommend confirming with Caldwell Pratt & Moorehouse LLP whether Intermediate Inc. should consider adopting a fiscal year ending May 31 to align with Pinnacle's operational measurement periods (which would simplify earnout tracking and financial reporting), or whether the calendar year is preferred for other reasons. A fiscal year adoption at this stage would require filing Form 1128 (Application to Adopt, Change, or Retain a Tax Year) and may not be available on an automatic basis; accordingly, calendar year should be retained unless there is a compelling business reason to change.
Quarterly estimated federal income tax payments are due as follows (for calendar year taxpayers):
• April 15 (first quarter)
• June 15 (second quarter)
• September 15 (third quarter)
• December 15 (fourth quarter)
State estimated tax payments are due in each state in which Intermediate Inc. has nexus. The specific due dates for each state are identified in Section VIII below.
Impact of Section 743(b) Amortization on Estimated Payments. The annual tax benefit from the Section 743(b) amortization deductions (approximately $20.04 million per year in deductions, yielding approximately $5.01 million per year in tax savings at a 25% blended rate) should be factored into Intermediate Inc.'s estimated tax computations to avoid overpayment of estimated taxes. Failure to account for these deductions in the estimated payment computation would result in unnecessary cash outflows that would reduce returns on invested capital.
First Partial-Year Payments. For the partial year from June 1 through December 31, 2024, Intermediate Inc. must annualize its income for the short period and compute estimated payments accordingly. Because the first two quarterly estimated payment dates (April 15 and June 15, 2024) will have passed before Intermediate Inc. begins operations (the closing occurred on May 31, 2024), the first estimated tax payment is likely due September 15, 2024. Caldwell Pratt & Moorehouse LLP should prepare a preliminary estimated tax computation by August 15, 2024 to ensure timely payment.
C. Pinnacle Health Services Group LLC (Partnership)
Pinnacle files Form 1065 (U.S. Return of Partnership Income) for the calendar year ending December 31, 2024. As discussed in Section III.E above, the 2024 return will reflect two distinct periods:
• Short period for pre-closing members: January 1 – May 31, 2024
• Post-closing period: June 1 – December 31, 2024 (Intermediate Inc. as sole member)
The Section 754 election will be filed with the 2024 return, as will Form 8308.
Pinnacle is not subject to federal entity-level income tax as a partnership. However, state-level partnership taxes may apply, as discussed in Section VIII below. In particular, Maryland's pass-through entity (PTE) tax election should be evaluated for the pre-closing period (see Section VIII.B.3).
D. Detailed Estimated Payment Calendar (First 12 Months Post-Closing)
The following table summarizes the estimated tax payments anticipated for the first twelve months following the closing. Dollar amounts are estimates based on preliminary projections and will be refined by Caldwell Pratt & Moorehouse LLP as actual financial data becomes available.
A complete estimated payment calendar with detailed computations and assumptions is provided as Exhibit C to this memorandum.
VIII. State Income Tax Return Filing Calendar