PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT
MEMORANDUM
To: Marcus Pellegrino, Partner, Healthcare, Ardent Capital Partners III LP Claire Ashworth, Co-Founder & Managing Partner, Ardent Capital Partners III LP
From: Leonard Cross, Partner, Tax, Calderwood & Harkness LLP Sylvia Hartwell, Partner, Tax, Calderwood & Harkness LLP Robert Jansen, Lead Associate, Tax, Calderwood & Harkness LLP
Date: February 20, 2024
Re: State and Local Tax Analysis — 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 analyze the state and local tax ("SALT") implications arising from Ardent Capital Partners III LP's ("Fund III" or "Ardent") proposed acquisition of one hundred percent (100%) of the membership interests in Pinnacle Health Services Group LLC ("Pinnacle" or the "Company") (EIN 82-1947632) at an enterprise value of approximately $412 million and an equity value of approximately $339.4 million. This memorandum is intended to assist Ardent's deal team in understanding the ongoing SALT obligations of the post-acquisition structure, the transaction-level tax considerations affecting closing mechanics, and the specific exposure areas warranting mitigation strategies prior to or concurrent with closing.
As discussed in greater detail in our separate federal tax memorandum dated February 14, 2024, the proposed transaction is structured as a three-tier acquisition in which Ardent Healthcare Holdings LLC, a newly formed Delaware limited liability company classified as a partnership for federal income tax purposes (EIN 93-2187445) ("Holdings LLC"), will be the ultimate parent holding entity. Holdings LLC will hold one hundred percent (100%) of the outstanding stock of Ardent Healthcare Intermediate Inc., a newly formed Delaware C-corporation serving as a blocker entity (EIN 93-2187512) ("Intermediate Inc."). Intermediate Inc. will, in turn, acquire one hundred percent (100%) of the membership interests in Pinnacle via a reverse merger of Ardent Healthcare Merger Sub LLC ("Merger Sub") with and into Pinnacle, with Pinnacle surviving the merger as a Delaware limited liability company maintaining its partnership classification for federal income tax purposes. The anticipated closing date is May 31, 2024.
Pinnacle operates across five states — Pennsylvania, Virginia, Maryland, North Carolina, and Georgia — through a network of thirty-four (34) urgent care clinics and eight (8) ambulatory surgery centers ("ASCs"), for a total of forty-two (42) facilities. In addition, we have identified New York as a state of concern due to the potential nexus created by the management activities of Holdings LLC, whose business address is co-located with Fund III at 600 Lexington Avenue, 38th Floor, New York, NY 10022.
Set forth below is a summary of our key SALT findings:
• Blended Effective State Income Tax Rate. The blended effective state income tax rate applicable to Intermediate Inc.'s share of Pinnacle's operating income is estimated at 6.42%, weighted by EBITDA allocation across the five operating states. This rate is additive to the 21% federal corporate rate for purposes of computing the after-tax value of Section 743(b) amortization deductions and the net present value of tax receivable agreement ("TRA") payments.
• Aggregate Nonresident Withholding Obligations. Aggregate nonresident withholding obligations on individual sellers are estimated at approximately $4.74 million, comprised of Virginia ($1.46 million), Maryland ($2.41 million), and Georgia ($0.87 million). These amounts will need to be deducted from seller proceeds at closing and remitted to the applicable state taxing authorities.
• Philadelphia Business Income & Receipts Tax. Three (3) of Pinnacle's clinics are located within the City of Philadelphia and are subject to the Philadelphia Business Income & Receipts Tax ("BIRT"), which imposes both a gross receipts tax component and a net income tax component. BIRT represents an incremental local tax burden that should be factored into the blended rate analysis for those facilities.
• Maryland Pass-Through Entity Tax Election. Maryland's elective pass-through entity ("PTE") tax, enacted in 2020, may be beneficial for nonresident individual sellers in the short taxable period ending at closing, as it provides a mechanism to circumvent the $10,000 federal SALT deduction cap imposed under IRC § 164(b)(6). Further coordination with Pinnacle's current accountants is required to determine feasibility and timing.
• New York Nexus Risk. Holdings LLC faces a moderate risk of New York nexus if it is deemed to conduct management or advisory activities in New York. We have identified a specific mitigation strategy involving the routing of management fee agreements through Ardent Capital GP III LLC (which is already nexused in New York) and Intermediate Inc., thereby preserving Holdings LLC's characterization as a passive holding entity.
• Pennsylvania Corporate Net Income Tax Rate Decline. Pennsylvania's corporate net income tax rate is scheduled to decline from 8.99% in 2024 to 4.99% by 2031 and thereafter. This rate phase-down will favorably impact Intermediate Inc.'s long-term effective state tax rate on Pennsylvania-sourced income and should be factored into the TRA projections and long-term tax models.
This memorandum is subject to the scope limitations and assumptions set forth in Section XV below. In particular, our analysis is based on information provided to date, and actual apportionment percentages, withholding amounts, and effective tax rates will be refined as additional financial data becomes available from Brewer Stanfield & Associates LLP, Pinnacle's current accountants, and Northmark Advisory Group LLC, the quality of earnings provider.
II. Transaction Structure — SALT Implications Overview
A. Proposed Acquisition Structure
The proposed acquisition employs a three-tier structure designed to accomplish several objectives, including the provision of a blocker entity for the benefit of Fund III's tax-exempt and non-U.S. limited partners, the facilitation of a Section 754 election and resulting Section 743(b) step-up in the inside basis of Pinnacle's assets, and the accommodation of rollover equity by certain of Pinnacle's founding physician-owners. The three tiers are structured as follows:
Tier 1 — Holdings LLC. Ardent Healthcare Holdings LLC is a newly formed Delaware limited liability company that will be classified as a partnership for federal income tax purposes. Holdings LLC will serve as the ultimate parent entity in the acquisition structure and will be the vehicle through which Fund III, the rollover participants, and any co-investment vehicles hold their economic interests. Holdings LLC will hold one hundred percent (100%) of the outstanding common stock of Intermediate Inc.
Tier 2 — Intermediate Inc. Ardent Healthcare Intermediate Inc. is a newly formed Delaware C-corporation that will serve as the "Blocker" entity interposed between Holdings LLC and Pinnacle. As a C-corporation, Intermediate Inc. will be the direct holder of one hundred percent (100%) of Pinnacle's membership interests post-closing and will be the entity-level state income taxpayer in states that impose corporate-level income or franchise tax on income flowing from Pinnacle's operations. The use of Intermediate Inc. as a blocker entity ensures that unrelated business taxable income ("UBTI") does not flow through to tax-exempt limited partners of Fund III and that non-U.S. limited partners are not directly engaged in a U.S. trade or business through Pinnacle.
Tier 3 — Pinnacle. Pinnacle Health Services Group LLC will survive the reverse merger of Merger Sub into Pinnacle and will continue to be classified as a partnership for federal (and state) income tax purposes. As a disregarded entity of Intermediate Inc. for federal tax purposes post-closing (given that Intermediate Inc. will be the sole member), Pinnacle's income and deductions will be reported on Intermediate Inc.'s consolidated federal income tax return. For state tax purposes, however, certain states may require separate entity reporting or impose entity-level tax on Pinnacle as a pass-through entity, and the treatment may vary depending on whether each state follows the federal disregarded entity classification.
B. State Tax Classification Considerations
The state tax classification of each entity in the acquisition structure is a foundational consideration for the SALT analysis, as it determines which entity bears the state income tax liability and how income flows through the structure for state tax purposes.
Pinnacle. Pinnacle is currently treated as a partnership for federal income tax purposes. No check-the-box election has been filed to alter this classification, and Pinnacle has been filing partnership returns (Form 1065 and applicable state equivalents) since its formation. All five operating states — Pennsylvania, Virginia, Maryland, North Carolina, and Georgia — recognize Pinnacle's partnership classification consistent with its federal classification. Post-closing, when Intermediate Inc. becomes Pinnacle's sole member, Pinnacle will be treated as a disregarded entity for federal tax purposes. For state tax purposes, certain states may continue to treat Pinnacle as a separate entity or may require composite or withholding returns, depending on the specific state's rules regarding single-member LLCs.
Intermediate Inc. Intermediate Inc. is organized as a Delaware corporation and will be treated as a C-corporation for both federal and state income tax purposes in all jurisdictions. As such, Intermediate Inc. will be subject to corporate income tax and, where applicable, franchise tax in each state where Pinnacle operates and creates nexus. Intermediate Inc.'s state taxable income will be computed by starting with its federal taxable income and making the required state-specific additions and subtractions, with the resulting adjusted income apportioned to each state using the applicable apportionment formula.
Holdings LLC. Holdings LLC is classified as a partnership for federal income tax purposes and will be treated as a partnership in all states. Holdings LLC itself does not operate any business directly; it exists solely to hold the stock of Intermediate Inc. and to serve as the vehicle through which investors hold their interests. The critical question with respect to Holdings LLC is whether its management activities — particularly those conducted at or near Fund III's New York offices — create independent nexus in any state, most notably New York. This issue is analyzed in detail in Section VIII below.
C. Rollover Participants — State Tax Exposure
Three of Pinnacle's founding physician-owners will participate in the rollover of a portion of their equity into Holdings LLC, thereby retaining an ongoing economic interest in Pinnacle's post-closing operations. The rollover participants and their respective positions are as follows:
• Dr. Raymond Carvallo — Total rollover equity of $32.41 million; cash-out proceeds of $97.24 million. Dr. Carvallo is a resident of Pennsylvania.
• Dr. Nadia Ostrowski — Total rollover equity of $24.18 million; cash-out proceeds of $72.55 million. Dr. Ostrowski is a resident of Pennsylvania.
• Jonathan Farnsworth — Total rollover equity of $2.95 million; cash-out proceeds of $16.74 million. Mr. Farnsworth is a resident of Pennsylvania.
In addition to the three founders, fourteen (14) minority physician-investors collectively hold approximately 27.5% of Pinnacle's outstanding membership interests, with aggregate equity proceeds of approximately $28.33 million. None of the minority physician-investors are participating in the rollover; all will fully cash out at closing.
The individual sellers — both the founders and the minority physician-investors — are subject to nonresident withholding requirements in states that impose such obligations on nonresident partners' shares of gain from the sale of partnership interests. Because the founders are all Pennsylvania residents, Pennsylvania's personal income tax at the 3.07% flat rate will apply to their respective shares of gain, though Pennsylvania does not impose entity-level withholding in the same manner as Virginia, Maryland, and Georgia. The residency of the fourteen minority physician-investors varies and will need to be confirmed for purposes of the detailed withholding computation schedule; however, to the extent any such investors are nonresidents of Virginia, Maryland, or Georgia, withholding obligations will apply to their state-apportioned shares of gain.
D. Apportionment Framework Overview
State income tax liability for Intermediate Inc. will be computed by apportioning its taxable income to each operating state based on the applicable apportionment formula. The apportionment methodologies in use across Pinnacle's five operating states are summarized as follows:
• Single-Sales-Factor Apportionment — Pennsylvania, Virginia, and Georgia each employ a single-sales-factor apportionment formula, meaning that one hundred percent (100%) of the apportionment is based on the ratio of in-state sales to total sales everywhere. This approach tends to benefit companies that have significant property and payroll in a state relative to their sales in that state, as property and payroll are excluded from the formula.
• Three-Factor Apportionment with Double-Weighted Sales — Maryland and North Carolina each employ a three-factor apportionment formula in which the sales factor is double-weighted. Under this methodology, the apportionment fraction is computed as the sum of the property factor, the payroll factor, and twice the sales factor, divided by four. This effectively weights sales at 50%, property at 25%, and payroll at 25%.
With respect to the sourcing of service revenue, all five operating states have adopted or are moving toward market-based sourcing for receipts from services. Under market-based sourcing, healthcare service receipts are sourced to the location of the patient, which, for urgent care and ambulatory surgery services, corresponds to the state in which the physical clinic or ASC is located. Because Pinnacle's services are inherently delivered at fixed physical locations, the sales factor will closely track the geographic distribution of Pinnacle's facilities and patient volume across states. A discussion of cost-of-performance rules is included at the state-by-state level below, although market-based sourcing is the applicable standard in all five states for the type of services Pinnacle provides.
The apportionment analysis is relevant not only to the ongoing determination of Intermediate Inc.'s entity-level state income tax liability but also to the computation of nonresident withholding obligations on gain from the sale of membership interests, as the gain recognized by nonresident sellers is apportioned to each state using the same apportionment methodology applicable to the entity's operating income.
III. Pennsylvania
A. Corporate Net Income Tax
Pennsylvania imposes a corporate net income tax ("CNIT") on the taxable income of corporations doing business in the Commonwealth. For tax year 2024, the CNIT rate is 8.99%. However, pursuant to Act 53 of 2022, Pennsylvania has enacted a multi-year phase-down of the CNIT rate that will significantly reduce the rate applicable to Intermediate Inc.'s Pennsylvania-sourced income over the projected hold period of Fund III's investment in Pinnacle. The phase-down schedule is as follows:
This long-term rate reduction is a meaningful favorable factor in the ongoing tax modeling for Intermediate Inc.'s Pennsylvania-sourced income. Assuming a five-to-seven-year hold period beginning in mid-2024, the effective Pennsylvania CNIT rate applicable to Pinnacle's Pennsylvania operations will decline by approximately 200 to 400 basis points over the course of the investment, which will have a favorable impact on after-tax cash flows and the net present value of the TRA payments.
Apportionment. Effective for tax years beginning on or after January 1, 2023, Pennsylvania adopted a single-sales-factor apportionment formula for purposes of the CNIT. Prior to 2023, Pennsylvania used a three-factor formula with double-weighted sales, but the transition to a pure sales-factor apportionment has now been fully implemented. Accordingly, Intermediate Inc.'s Pennsylvania apportionment percentage will be determined solely by the ratio of its Pennsylvania sales to its sales everywhere.
Sourcing. Pennsylvania has adopted market-based sourcing for receipts from the sale of services. Under 72 Pa. Stat. § 7401(3)2.(a)(17), receipts from the performance of services are sourced to the state where the benefit of the service is received. For healthcare services, the benefit is received at the location of the patient, which corresponds to the location of the urgent care clinic or ASC where the patient receives treatment. Because Pinnacle's healthcare services are delivered at physical clinic and ASC locations, the sales factor sourcing analysis for Pennsylvania is relatively straightforward — receipts from services performed at Pennsylvania facilities are sourced to Pennsylvania.
Revenue Allocation. Pinnacle operates a significant concentration of its facilities in Pennsylvania, consistent with its headquarters location in King of Prussia, Pennsylvania. Of Pinnacle's thirty-four (34) urgent care clinics and eight (8) ASCs (forty-two (42) total), a substantial portion are located in the Commonwealth. Based on preliminary information, Pennsylvania represents the largest single state in terms of both facility count and revenue. For tax year 2023, Pinnacle reported total revenue of approximately $287.4 million. The Pennsylvania apportionment percentage will be computed based on PA-sourced revenue as a proportion of total revenue; the specific percentage will be refined upon receipt of Pinnacle's historical state-by-state revenue breakdown from Brewer Stanfield & Associates LLP.
B. Philadelphia Business Income & Receipts Tax (BIRT)
Three (3) of Pinnacle's urgent care clinics are located within the geographic boundaries of the City of Philadelphia. These clinics are subject to the Philadelphia Business Income & Receipts Tax ("BIRT"), which is imposed under the Philadelphia Code, Title 19, Chapter 19-2600, on any person or entity conducting business activity within the City of Philadelphia.
BIRT is comprised of two components:
(i) Gross Receipts Tax. A tax imposed at the rate of 1.415 mills (i.e., $1.415 per $1,000 of taxable gross receipts, or approximately 0.1415%). This component is assessed on the gross receipts attributable to business activities conducted within Philadelphia. Unlike the net income component, the gross receipts tax is imposed regardless of profitability.
(ii) Net Income Tax. A tax imposed at the rate of 5.99% on the net income attributable to business activities conducted within Philadelphia. Net income for BIRT purposes is computed based on the entity's net income as reported for federal income tax purposes, with certain adjustments as prescribed by the Philadelphia Code.
Pinnacle's Philadelphia operations generate BIRT nexus regardless of the entity's classification for federal or state income tax purposes, as BIRT applies broadly to any entity having business activity within the City. Post-acquisition, the revenue and net income attributable to the three Philadelphia clinics will continue to be subject to BIRT.
Mitigation Strategies. We recommend evaluating whether the segregation of the three Philadelphia clinic operations into a separate legal entity (e.g., a separate subsidiary LLC) could limit the BIRT exposure by confining the gross receipts and net income subject to BIRT to only those receipts and income directly attributable to the Philadelphia operations, rather than risking a broader allocation of Pinnacle's overall income to Philadelphia. However, given that only three (3) of forty-two (42) total facilities are located in Philadelphia, the cost-benefit analysis of such a structural segregation must take into account the incremental administrative burden, any potential adverse federal or state tax consequences, and the regulatory implications of restructuring healthcare operations. We recommend that this analysis be conducted in coordination with Harcourt Shaw & DeVries LLP and Pinnacle's regulatory counsel.
Impact on Blended Effective Rate. The BIRT represents an incremental local tax burden that is additive to the Pennsylvania CNIT for the three Philadelphia clinics. When computing the blended effective state and local tax rate, the BIRT net income component (5.99%) should be allocated to the revenue attributable to the Philadelphia clinics. The gross receipts component, being a tax on revenue rather than income, is treated as a cost of doing business and reduces pre-tax income rather than being reflected in the income tax rate.
C. Pennsylvania Capital Stock / Franchise Tax
Pennsylvania phased out its capital stock/franchise tax effective January 1, 2016. Accordingly, neither Intermediate Inc. nor Pinnacle is subject to a capital stock or franchise tax in Pennsylvania. No filing obligation exists with respect to this formerly applicable tax.
D. Sales and Use Tax
Pennsylvania imposes a state sales and use tax at a rate of 6.0%, with an additional 2.0% local tax applicable in Philadelphia (for a combined rate of 8.0% in Philadelphia) and a 1.0% local tax in Allegheny County (for a combined rate of 7.0% in Allegheny County).
Healthcare services provided by Pinnacle are generally exempt from Pennsylvania sales tax. The Commonwealth does not impose sales tax on medical or healthcare services rendered to patients. However, purchases of medical equipment, supplies, and other tangible personal property by Pinnacle may be subject to sales and use tax unless a specific exemption applies. Pennsylvania provides exemptions for certain items used directly in the rendition of medical services, including prescription medications and certain medical devices. A more detailed analysis of the sales tax exemption status of Pinnacle's equipment purchases is beyond the scope of this memorandum but should be addressed as part of the post-closing compliance review to ensure that Pinnacle has been properly applying exemptions and self-assessing use tax on taxable purchases where required.
We note that post-closing equipment acquisitions — including capital expenditures for new clinic build-outs or ASC expansions — should be reviewed for sales and use tax applicability on a transaction-by-transaction basis, and that the Philadelphia 2.0% local surtax should be accounted for with respect to taxable purchases made for the three Philadelphia clinics.
E. Pennsylvania Nonresident Withholding on Sale
Pennsylvania does not impose entity-level withholding on nonresident partners' shares of gain from the sale of partnership interests in the same manner as Virginia, Maryland, and Georgia. Accordingly, there is no mandatory withholding obligation at the Pinnacle entity level that must be deducted from closing proceeds for Pennsylvania purposes.
However, nonresident individual sellers who have Pennsylvania-sourced income from Pinnacle's operations may have individual filing obligations in Pennsylvania. For the three founders — Dr. Raymond Carvallo, Dr. Nadia Ostrowski, and Jonathan Farnsworth — all of whom are Pennsylvania residents, the gain on the sale of their Pinnacle membership interests will be subject to Pennsylvania personal income tax at the flat rate of 3.07% on all taxable income. This is a filing obligation of the individual sellers rather than a withholding obligation of the entity, and the founders should be advised to account for the Pennsylvania personal income tax liability on their 2024 individual returns. We understand that the founders are represented by Whitford & Gaines LLP (Patricia Engelman) with respect to their individual tax matters, and we recommend coordination with Ms. Engelman regarding the founders' Pennsylvania tax positions.
For the fourteen minority physician-investors, to the extent any are nonresidents of Pennsylvania who have derived PA-sourced income from Pinnacle's operations during the 2024 tax year (through the date of closing), they may have Pennsylvania nonresident filing obligations. The gain on the sale of their membership interests, to the extent apportioned to Pennsylvania, would be subject to Pennsylvania personal income tax at the 3.07% rate. We will coordinate with Brewer Stanfield & Associates LLP to identify any nonresident minority investors with Pennsylvania filing obligations.
IV. Virginia
A. Corporate Income Tax
Virginia imposes a corporate income tax at a flat rate of 6.0% on Virginia taxable income of corporations doing business in the Commonwealth. Intermediate Inc. will be subject to Virginia corporate income tax on the portion of Pinnacle's income that is apportioned to Virginia.
Apportionment. Effective for tax years beginning on or after January 1, 2021, Virginia adopted a single-sales-factor apportionment formula for corporations that have qualifying apportionable income. Previously, Virginia used a three-factor formula with double-weighted sales. The transition to single-sales-factor apportionment is now fully effective and will apply to Intermediate Inc.'s Virginia tax computation. Accordingly, Intermediate Inc.'s Virginia apportionment percentage will be determined solely by the ratio of its Virginia sales (i.e., receipts sourced to Virginia) to its total sales everywhere.
Sourcing. Virginia follows market-based sourcing rules for receipts from the sale of services. Under Virginia Code § 58.1-416, service receipts are sourced to the state where the benefit of the service is delivered or received. For Pinnacle's healthcare services, this means that receipts from services performed at Virginia-located clinics and ASCs are sourced to Virginia based on the patient's location, which, given the in-person nature of urgent care and ambulatory surgery, corresponds to the physical location of the facility where the service is rendered.
Pinnacle operates a number of urgent care clinics and ASCs in Virginia, which constitutes a meaningful but not predominant share of total operations. The precise Virginia apportionment percentage will be determined based on the ratio of Virginia-sourced receipts to total receipts, using Pinnacle's historical revenue data.
B. Nonresident Withholding
Virginia imposes a withholding obligation on pass-through entities with respect to the distributive share of Virginia-source income allocable to nonresident members. The withholding rate is 5.0% of the nonresident member's share of Virginia-source income. See Va. Code § 58.1-486.2.
For purposes of the Pinnacle acquisition, Virginia withholding will apply to nonresident individual sellers on their respective shares of gain from the sale of Pinnacle membership interests, to the extent such gain is apportioned to Virginia under Virginia's single-sales-factor apportionment formula.
Estimated Virginia Withholding: $1,460,000.
The computation is based on each nonresident individual seller's pro rata share of gain on the sale (aggregate equity value of $339.4 million less aggregate outside basis), apportioned to Virginia using the single-sales-factor formula, and multiplied by the 5.0% withholding rate. A detailed computation will be prepared in the Nonresident Withholding Computation Schedule, which we anticipate delivering on or before May 15, 2024.
The withholding is required to be remitted by Pinnacle (or the surviving entity post-merger) at or before the time of closing, and the mechanics of the withholding must be coordinated with the closing funds flow. The withheld amounts will be reported on Virginia Form 502, and individual sellers will receive credit for the amounts withheld on their individual Virginia nonresident income tax returns (Form 763).
C. Pass-Through Entity Tax
Virginia enacted an elective pass-through entity tax ("PTE tax") under Va. Code § 58.1-390.1 et seq. Under this election, a qualifying pass-through entity may elect to pay tax at the entity level at a rate equal to the top individual income tax rate, which is currently 5.75%. Members of the electing entity receive a corresponding credit against their individual Virginia income tax liabilities.
The primary benefit of the Virginia PTE tax election is that the entity-level tax payment is treated as a deduction from the entity's gross income for federal income tax purposes, thereby circumventing the $10,000 limitation on the deduction of state and local taxes imposed on individual taxpayers under IRC § 164(b)(6) (the "SALT cap"). This benefit is most significant for Virginia-resident members who itemize deductions and whose total state and local tax payments exceed $10,000.
Analysis. For the short taxable period ending at closing (May 31, 2024), the Virginia PTE election would primarily benefit Virginia-resident members of Pinnacle (if any) who could claim the credit against their individual Virginia returns. For nonresident members, the benefit depends on whether their state of residency provides a credit for PTE tax paid to Virginia. Given that the three founding partners are all Pennsylvania residents, and Pennsylvania generally provides credits for taxes paid to other states, the PTE election could provide a marginal benefit. However, the administrative complexity of making the election for a short taxable period, combined with the fact that the withholding mechanism already provides credits to nonresident sellers, suggests that the incremental benefit of the PTE election for Virginia may be limited.
Recommendation. The Virginia PTE election is not recommended for the short taxable period ending at closing. Post-closing, the PTE election analysis becomes less relevant for Virginia because Intermediate Inc. (a C-corporation) will be the direct holder of Pinnacle's membership interests, and Intermediate Inc. will pay Virginia corporate income tax directly on its Virginia-apportioned income. The PTE election is not applicable to C-corporation members.
D. Virginia Franchise / Registration Fees
Virginia imposes nominal registration fees on limited liability companies registered to do business in the Commonwealth. The annual registration fee for a foreign LLC is $50. This cost is immaterial and does not warrant detailed analysis, but Pinnacle's Virginia registration should be confirmed as current, and Intermediate Inc. may need to register as a foreign corporation authorized to do business in Virginia if it is deemed to have nexus by virtue of Pinnacle's operations in the state.
V. Maryland
A. Corporate Income Tax
Maryland imposes a corporate income tax at a rate of 8.25% on the Maryland taxable income of corporations doing business in the State. This rate is one of the higher state corporate income tax rates among Pinnacle's operating states and will be a meaningful contributor to the blended effective state tax rate applicable to Intermediate Inc.'s share of Pinnacle's income.
Intermediate Inc. will be subject to Maryland corporate income tax on the portion of Pinnacle's income that is apportioned to Maryland.
Apportionment. Maryland utilizes a three-factor apportionment formula with the sales factor double-weighted. Under this methodology, the apportionment fraction is computed as follows:
Apportionment Percentage = (Property Factor + Payroll Factor + (2 × Sales Factor)) ÷ 4
This effectively weights the factors as follows: property at 25%, payroll at 25%, and sales at 50%. Unlike Pennsylvania, Virginia, and Georgia (each of which has adopted a pure single-sales-factor formula), Maryland's retention of a three-factor formula means that the relative concentration of Pinnacle's property and payroll in Maryland will affect the apportionment percentage. To the extent Pinnacle has significant clinic leaseholds, leasehold improvements, medical equipment, and payroll in Maryland relative to its other operating states, the Maryland apportionment percentage may exceed the percentage that would result from a single-sales-factor analysis.
Sourcing. Maryland has adopted market-based sourcing for receipts from the sale of services. Under Md. Code Ann., Tax-Gen. § 10-402, service receipts are sourced to the state where the benefit of the service is received. For Pinnacle's healthcare services, this results in receipts being sourced to Maryland based on the location of the patient, which corresponds to the location of the Maryland facility where the patient receives treatment.
B. Pass-Through Entity Tax Election Analysis
Maryland's Elective Pass-Through Entity Tax was enacted in 2020 (SB 523, effective for tax years beginning after December 31, 2019) and provides qualifying pass-through entities with the option to pay state income tax at the entity level. This election has become particularly significant in light of the federal SALT deduction cap, as the entity-level tax payment is deductible for federal income tax purposes, effectively allowing members of the pass-through entity to circumvent the $10,000 limitation under IRC § 164(b)(6).
Rate. When a Maryland PTE tax election is made, the entity pays tax at a rate equal to the sum of the top individual income tax rate (currently 5.75%) plus the lowest county income tax rate (currently 2.25% for Worcester County) or, alternatively, the specific county rate applicable to each member based on the member's county of residence (for Maryland residents). For nonresident members, the rate is the top state rate (5.75%) plus the lowest county rate (2.25%), resulting in an effective PTE tax rate of 8.0% for nonresidents.
Credit Mechanism. Each member of the electing PTE receives a credit equal to the member's proportionate share of the entity-level PTE tax paid. Resident members claim the credit against their Maryland individual income tax liabilities, while nonresident members claim the credit against their home state income tax liabilities (subject to the home state's credit rules for taxes paid to other states).
Analysis for Nonresident Individual Sellers. The Maryland PTE election is potentially beneficial for the nonresident individual sellers of Pinnacle membership interests for two principal reasons:
(i) Federal SALT Deduction. The entity-level PTE tax payment is deductible in computing the entity's federal taxable income, effectively allowing each member to obtain a federal tax benefit for the state tax paid on their behalf. In the absence of the PTE election, individual sellers would be subject to the $10,000 SALT cap, and any Maryland income tax in excess of $10,000 would not be deductible for federal purposes.
(ii) Home State Credit. Nonresident sellers can claim a credit on their home state income tax returns for their share of the Maryland PTE tax paid. For the three founders, who are Pennsylvania residents, Pennsylvania generally provides a credit for income taxes paid to other states (subject to limitations), which would offset their Pennsylvania personal income tax liability on the same income.
Recommendation. The Maryland PTE election should be analyzed for the short taxable period ending May 31, 2024. If Pinnacle files a short-period partnership return for the period January 1, 2024, through May 31, 2024, the PTE election may be made on that return. We recommend coordination with Brewer Stanfield & Associates LLP, Pinnacle's current accountants, to determine the mechanics and timing of making the election and to assess whether the election can be made for a short taxable period under Maryland's rules. Additionally, coordination with Whitford & Gaines LLP (Patricia Engelman), counsel to the individual sellers, is necessary to ensure that the sellers' individual tax positions are optimized.
Post-closing, the relevance of the Maryland PTE election diminishes, because Intermediate Inc. — a C-corporation — will be the sole member of Pinnacle. Intermediate Inc. pays Maryland corporate income tax directly at the entity level, and the PTE election is not applicable (or necessary) for C-corporation members. The PTE election is a planning tool for pass-through entities with individual (or pass-through) members, and the interposition of Intermediate Inc. as a C-corporation blocker effectively moots the PTE analysis for ongoing operations.
C. Nonresident Withholding
Maryland imposes withholding on the distributive share of Maryland-source income allocable to nonresident members of pass-through entities. The withholding rate is the highest individual income tax rate, currently 5.75% for the state component, plus the applicable county income tax rate. For nonresident members, the county rate applied is generally the lowest county rate (2.25% for Worcester County), resulting in a combined withholding rate of approximately 8.0%. However, the specific rate may vary depending on the interpretation applied by the Comptroller of Maryland. For purposes of our estimate, we have used a blended rate that produces the estimated withholding amount set forth below.
Estimated Maryland Withholding: $2,410,000.
This represents the largest single-state withholding obligation among the five operating states. The computation is based on each nonresident individual seller's pro rata share of gain from the sale of Pinnacle membership interests, apportioned to Maryland using Maryland's three-factor double-weighted-sales apportionment formula, and multiplied by the applicable withholding rate. The detailed computation will be included in the Nonresident Withholding Computation Schedule to be delivered prior to closing.
Mechanics. The withholding amount must be deducted from the nonresident sellers' closing proceeds and remitted to the Comptroller of Maryland within the prescribed statutory period. We recommend that the withholding be funded from the closing proceeds concurrently with the closing on May 31, 2024, and that the mechanics be coordinated with Ironbridge Trust Company, N.A. (the escrow agent) and the closing funds flow prepared by Harcourt Shaw & DeVries LLP.
If the Maryland PTE election is made for the short taxable period, the interaction between the PTE tax payment and the nonresident withholding obligation must be carefully coordinated to avoid double payment. Maryland's rules generally provide that PTE tax payments satisfy the withholding obligation for the same period, but the mechanics must be confirmed with the Comptroller.
D. Maryland Franchise Tax
Maryland imposes an annual franchise tax on corporations organized in or doing business in the State. The franchise tax is based on the assessed value of all stock, with rates depending on the par value of the corporation's outstanding shares. For most corporations, the franchise tax is a nominal filing fee and does not represent a significant cost driver. Intermediate Inc. will need to register as a foreign corporation authorized to do business in Maryland and pay the annual franchise tax filing fee. The estimated annual cost is minimal (typically in the range of $300 to a few thousand dollars depending on the computation) and does not warrant detailed modeling.
VI. North Carolina
A. Corporate Income Tax
North Carolina imposes a corporate income tax on corporations doing business in the State. The current rate for tax year 2024 is 2.5%, which represents the culmination of a multi-year phase-down from 6.9% in 2013. North Carolina has the lowest corporate income tax rate among Pinnacle's five operating states, and there is pending legislation that would potentially reduce the rate further or eliminate it entirely in future years, although no such legislation has been enacted as of the date of this memorandum.
Intermediate Inc. will be subject to North Carolina corporate income tax on the portion of Pinnacle's income apportioned to North Carolina.
Apportionment. North Carolina uses a three-factor apportionment formula with the sales factor double-weighted. The formula is computed as follows:
Apportionment Percentage = (Property Factor + Payroll Factor + (2 × Sales Factor)) ÷ 4
This methodology is consistent with Maryland's approach, weighting property at 25%, payroll at 25%, and sales at 50%. The North Carolina apportionment percentage for Intermediate Inc. will be determined based on the relative proportion of Pinnacle's property, payroll, and sales located in or sourced to North Carolina.
Sourcing. North Carolina has adopted market-based sourcing for receipts from the sale of services. Under N.C. Gen. Stat. § 105-130.4(l)(3), service receipts are sourced to the state where the benefit of the service is received. For Pinnacle's healthcare services, this results in receipts being sourced to North Carolina based on the location of the patient, consistent with the approach in the other operating states.
Given the low rate, North Carolina contributes favorably to the blended effective state tax rate. Even if Pinnacle has a meaningful concentration of operations in North Carolina, the 2.5% rate ensures that the North Carolina component of the blended rate is modest.
B. Franchise Tax
Unlike several of the other operating states, North Carolina imposes a franchise tax on corporations doing business in the State, in addition to the corporate income tax. The North Carolina franchise tax is imposed under N.C. Gen. Stat. § 105-122 and is computed based on the largest of three alternative tax bases:
(i) The corporation's issued and outstanding capital stock, surplus, and undivided profits apportioned to North Carolina;
(ii) Fifty-five percent (55%) of the appraised value of all real and tangible personal property located in North Carolina; or
(iii) The actual investment in tangible property in North Carolina.
The franchise tax rate is $1.50 per $1,000 of the largest tax base, with a minimum tax of $200 per year. For Intermediate Inc., the franchise tax base will be determined primarily by the appraised value of Pinnacle's North Carolina-located tangible property (including medical equipment, leasehold improvements, and other fixed assets) and by Intermediate Inc.'s capital and surplus apportioned to North Carolina.
While the franchise tax is not expected to be a major cost relative to Pinnacle's overall revenue, it does require annual computation and filing. We recommend that the franchise tax liability be estimated as part of the post-closing compliance setup, and that Intermediate Inc. be registered as a foreign corporation authorized to do business in North Carolina, with the initial franchise tax return filed in the first year following the acquisition.
C. Nonresident Withholding
North Carolina requires withholding on the distributive share of North Carolina-source income allocable to nonresident members of pass-through entities. The withholding rate corresponds to the applicable individual income tax rate, which for tax year 2024 is currently 4.5% (North Carolina has been progressively reducing its individual income tax rate in parallel with the corporate rate reductions).
Pinnacle's North Carolina operations represent a smaller proportion of overall revenue compared to Pennsylvania, and the North Carolina withholding amount for nonresident individual sellers is expected to be relatively modest. The $4.74 million aggregate withholding estimate referenced in the Executive Summary specifically identifies Virginia ($1.46 million), Maryland ($2.41 million), and Georgia ($0.87 million) as the three states with the most significant withholding obligations. North Carolina withholding, to the extent applicable, may be de minimis depending on the sellers' residency and the proportion of gain apportioned to North Carolina. Alternatively, certain nonresident sellers may satisfy their North Carolina tax obligations through individual filing rather than through entity-level withholding. The specific North Carolina withholding obligation will be computed and included in the detailed Nonresident Withholding Computation Schedule.
VII. Georgia
A. Corporate Income Tax
Georgia imposes a corporate income tax at a rate of 5.75% on the Georgia taxable income of corporations doing business in the State. Intermediate Inc. will be subject to Georgia corporate income tax on the portion of Pinnacle's income apportioned to Georgia.
Apportionment. Georgia offers taxpayers the option of electing single-sales-factor apportionment for tax years beginning on or after January 1, 2008 (applicable to multistate corporations that qualify under the election provisions of O.C.G.A. § 48-7-31(d)). The default apportionment method is a three-factor formula with equally weighted property, payroll, and sales factors. However, multistate taxpayers that meet the eligibility requirements may irrevocably elect single-sales-factor apportionment.
Recommendation. We recommend analyzing whether the single-sales-factor election produces a lower Georgia apportionment percentage for Intermediate Inc. than the default three-factor formula. The determination depends on the relative proportion of Pinnacle's sales, property, and payroll located in Georgia compared to its total operations across all states. If Georgia represents a disproportionately larger share of sales relative to property and payroll (or vice versa), one formula may be more favorable than the other. We will need Pinnacle's historical factor data to complete this analysis and will coordinate with Brewer Stanfield & Associates LLP to obtain the necessary information.
Sourcing. Georgia follows market-based sourcing for receipts from the sale of services. Service receipts are sourced to the state where the customer receives the benefit of the service, which for Pinnacle's healthcare services corresponds to the location of the Georgia clinic or ASC where the patient is treated.
B. Nonresident Withholding
Georgia imposes withholding on nonresident members' distributive shares of Georgia-source income at the rate of 5.75%. See O.C.G.A. § 48-7-129. This withholding requirement applies to nonresident individual sellers of Pinnacle membership interests on their respective shares of gain apportioned to Georgia.
Estimated Georgia Withholding: $870,000.
The computation is based on each nonresident individual seller's pro rata share of gain from the sale of Pinnacle membership interests, apportioned to Georgia using the applicable apportionment formula (either single-sales-factor or three-factor, depending on the election made), and multiplied by the 5.75% withholding rate.
Mechanics. The Georgia withholding must be deducted from the nonresident sellers' closing proceeds and remitted to the Georgia Department of Revenue. The remittance mechanics are similar to those for Virginia and Maryland, and should be coordinated with the closing funds flow to ensure that sufficient proceeds are withheld and properly remitted on behalf of each nonresident seller. Sellers will receive credit for the amounts withheld on their individual Georgia nonresident income tax returns.
C. Georgia Net Worth Tax
Georgia imposes a net worth tax on corporations with Georgia nexus. The net worth tax is imposed under O.C.G.A. § 48-13-70 et seq. and is based on the net worth of the corporation as allocated or apportioned to Georgia. The tax is assessed on a graduated rate schedule based on the corporation's Georgia net worth, with rates ranging from $10 (for corporations with net worth of $10,000 or less) to $5,000 (for corporations with net worth exceeding $22 million).
For Intermediate Inc., the Georgia net worth tax is expected to be a nominal amount — likely at or near the maximum of $5,000 per year, depending on the net worth allocated to Georgia. While the amount is immaterial in the context of the overall transaction, compliance filing is required, and Intermediate Inc. must ensure that its Georgia net worth tax return is filed annually in conjunction with its Georgia corporate income tax return.
VIII. New York Nexus Analysis
A. Risk Identification
Although Pinnacle does not operate any facilities in New York and has no patients, employees, or tangible property located in the State, we have identified a potential New York nexus risk arising from the management activities of Holdings LLC. Specifically, Holdings LLC's business address is 600 Lexington Avenue, 38th Floor, New York, NY 10022, which is the same address as Ardent Capital Partners III LP and its general partner, Ardent Capital GP III LLC. The co-location of Holdings LLC with Fund III's New York offices raises the question of whether Holdings LLC itself conducts business in New York by virtue of management activities, investment decision-making, board-level governance, and oversight of Pinnacle that take place at or near the Fund III offices.
New York imposes income tax on partnerships and their members if the partnership has New York-source income or is deemed to be conducting a trade or business within the State. Under N.Y. Tax Law § 631(b)(1)(A) and related provisions, nonresident individuals who are members of a partnership that carries on a trade, business, profession, or occupation in New York are subject to New York income tax on their shares of partnership income derived from New York sources.
If Holdings LLC is treated as conducting business in New York — for example, if its managing members or managers make investment decisions, negotiate contracts, or provide management or advisory services from New York — then Holdings LLC could be deemed to have New York nexus. This would result in Holdings LLC being required to file a New York partnership return (Form IT-204) and to report its members' shares of income allocable to New York. The consequences for Holdings LLC's members — including Fund III, the rollover participants (Dr. Carvallo, Dr. Ostrowski, and Mr. Farnsworth), and any co-investment vehicles — could be significant:
• Rollover participants would be subject to New York nonresident income tax on their shares of Holdings LLC income apportioned to New York, at rates up to 10.9% for individuals (plus applicable New York City tax if the income is also allocated to NYC).
• Fund III limited partners who are nonresidents of New York could face individual New York filing obligations and tax liabilities on their shares of Fund III income that flows through Holdings LLC and is sourced to New York.
• Intermediate Inc. — as a C-corporation — is separately subject to New York's corporate franchise tax (at rates up to 7.25% on the business income base for qualified manufacturers; higher for other taxpayers) if it is deemed to have New York nexus. However, Intermediate Inc.'s nexus with New York, if any, would arise from its own activities rather than from Holdings LLC's activities, and the analysis for Intermediate Inc. is somewhat independent.
B. Nexus Mitigation Strategy
The primary goal of the nexus mitigation strategy is to ensure that Holdings LLC is treated as a passive holding entity that does not independently conduct any trade, business, or management activity in New York. Fund III's existing New York nexus is unavoidable, as Ardent Capital GP III LLC (the general partner of Fund III) is located in New York and conducts investment management activities from New York. However, the goal is to prevent Holdings LLC from creating independent nexus that would flow through to the rollover participants and other direct members of Holdings LLC who are not otherwise connected to New York.
The recommended mitigation steps are as follows:
(1) Management Fee Agreement Routing. All management fee agreements and advisory services agreements relating to the oversight and management of Pinnacle's operations should be structured as agreements between Ardent Capital GP III LLC (or a management company affiliate) and Ardent Healthcare Intermediate Inc. Holdings LLC should not be a party to any management, advisory, or consulting agreement. By routing the management fee through GP III (which is already nexused in New York) and Intermediate Inc. (which is a C-corporation taxpayer), the management activity is attributable to entities that are already subject to New York tax or that pay tax at the entity level, rather than flowing through Holdings LLC to its individual members.
(2) Passive Holding Characterization. Holdings LLC should not employ any personnel, maintain office space in its own name, or enter into any contracts (other than its operating agreement and the stock ownership documents relating to its interest in Intermediate Inc.). Holdings LLC's sole activity should be holding its interest in Intermediate Inc. and receiving dividend distributions from Intermediate Inc. The operating agreement of Holdings LLC should be drafted (or amended) to clearly reflect this passive holding characterization.
(3) Board Meeting and Governance Location. Board meetings and governance activities of Intermediate Inc. and Pinnacle should be conducted outside New York to the maximum extent practicable. If any meetings are held in New York, such meetings should be conducted as activities of Intermediate Inc. (which, as a C-corporation, pays entity-level tax) rather than activities of Holdings LLC. Meeting minutes should clearly identify the participants and their capacities, and care should be taken to ensure that Holdings LLC is not the entity convening or directing such meetings.
(4) Documentation. All organizational documents, operating agreements, and resolutions should be reviewed to confirm that Holdings LLC's sole stated purpose is to hold its interest in Intermediate Inc. and that Holdings LLC is not authorized or directed to engage in management, advisory, or operational activities. We recommend that Harcourt Shaw & DeVries LLP review the operating agreement of Holdings LLC to confirm the passive holding characterization and to ensure that no provisions inadvertently create an argument that Holdings LLC is conducting business in New York.
C. Residual Risk Assessment
Even with the implementation of the mitigation steps described above, there is a residual risk that the New York Department of Taxation and Finance could assert that Holdings LLC has New York nexus under economic nexus theories, substance-over-form arguments, or agency principles. For example, if the individuals who manage Holdings LLC (e.g., Fund III personnel who serve as officers or managers of Holdings LLC) perform their activities from New York, New York could argue that Holdings LLC is conducting business through its agents in New York, notwithstanding the formal passive holding characterization.
We assess the risk level as follows:
• Moderate risk if the mitigation steps described above are implemented consistently and documented contemporaneously.
• High risk if Holdings LLC directly contracts for management services, employs personnel, or otherwise engages in activities beyond passive holding — particularly if such activities are conducted from New York.
Recommendation. We recommend implementing all mitigation steps prior to closing. The operating agreement of Holdings LLC should be finalized and reviewed by Harcourt Shaw & DeVries LLP, and the management fee agreement should be executed between Ardent Capital GP III LLC and Intermediate Inc. (not Holdings LLC) prior to or concurrently with the closing. Post-closing, ongoing compliance with the passive holding characterization should be monitored, and any changes to Holdings LLC's activities should be reviewed for potential New York nexus implications.
IX. Apportionment Methodology Summary
A. Comparative Table of Apportionment Methods by State
The following table summarizes the apportionment methodology applicable in each of Pinnacle's five operating states:
As reflected in the table, three of the five operating states (Pennsylvania, Virginia, and Georgia) employ a pure single-sales-factor formula, while two states (Maryland and North Carolina) retain a three-factor formula with the sales factor double-weighted. The choice between single-sales-factor and three-factor apportionment can have a material impact on the amount of income apportioned to a particular state, depending on the relative distribution of the company's property, payroll, and sales across states.
For Pinnacle, the impact of the apportionment methodology depends on the geographic distribution of its operations. Because Pinnacle's services are delivered at physical locations and patient volume drives revenue, the sales factor in each state will tend to correlate with facility count and patient throughput in that state. In states using single-sales-factor apportionment (PA, VA, GA), the apportionment percentage will be determined entirely by revenue distribution. In states using three-factor apportionment (MD, NC), property (clinic leaseholds, medical equipment, leasehold improvements) and payroll (physicians, nurses, administrative staff at MD and NC locations) will also influence the apportionment percentage.
B. Revenue Sourcing — Healthcare Services
All five operating states have adopted or are moving toward market-based sourcing for receipts from the sale of services. Under market-based sourcing, the sales factor numerator includes receipts from services whose benefits are received in the state. For healthcare services — including urgent care visits and ambulatory surgical procedures — the benefit is received at the location where the patient obtains the medical service, which corresponds to the physical location of the clinic or ASC.
Because Pinnacle's services are inherently delivered at fixed physical locations (patients travel to the clinic or ASC to receive care), the sales factor sourcing analysis is relatively straightforward: receipts from services performed at facilities located in a given state are sourced to that state. There is minimal complexity associated with multi-state service delivery or remote/virtual service provisions, as the nature of urgent care and ambulatory surgery requires in-person patient interaction at a specific facility.
The estimated distribution of revenue by state will be determined based on Pinnacle's facility count and historical patient volume data. As noted above, Pinnacle operates a total of forty-two (42) facilities (34 urgent care clinics and 8 ASCs) across Pennsylvania, Virginia, Maryland, North Carolina, and Georgia. The specific state-by-state allocation of revenue will be refined upon receipt of Pinnacle's historical revenue data from Brewer Stanfield & Associates LLP, which we have requested and anticipate receiving by early March 2024.
C. Impact on Blended Effective State Rate
The blended effective state income tax rate applicable to Intermediate Inc.'s share of Pinnacle's operating income is estimated at 6.42%. This rate is computed using a weighted-average methodology in which each state's corporate income tax rate is multiplied by the estimated apportionment percentage to that state (based on EBITDA allocation), and the resulting state-specific tax amounts are summed and divided by total apportioned income.
The blended effective rate of 6.42% is significant in two primary contexts:
(i) Total Effective Tax Rate. The blended state rate is additive to the 21% federal corporate income tax rate for purposes of computing Intermediate Inc.'s total effective tax rate on Pinnacle's operating income. After accounting for the federal deductibility of state income taxes, the combined federal-state effective rate is approximately 25% (21% federal + approximately 4% net state rate after the federal deduction). This 25% blended rate is used in the step-up net present value analysis for purposes of computing the after-tax value