PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION
CALDERWOOD & HARKNESS LLP One Liberty Plaza, 45th Floor New York, NY 10006
Telephone: (212) 848-6100 Facsimile: (212) 848-6199
Engagement No.: 1001-00006 Matter No.: 1001-00006
March 18, 2024
Marcus Pellegrino, Partner, Healthcare Ardent Capital Partners III LP 600 Lexington Avenue, 38th Floor New York, NY 10022
Re: State and Local Tax Structuring Recommendations — Acquisition of Pinnacle Health Services Group LLC (EIN 82-1947632) by Ardent Capital Partners III LP
Dear Mr. Pellegrino:
cc: Claire Ashworth, Co-Founder & Managing Partner, Ardent Capital Partners III LP cc: Thomas Kundra, Partner, M&A, Harcourt Shaw & DeVries LLP, 51 West 52nd Street, New York, NY 10019
I. Introduction and Purpose
Calderwood & Harkness LLP ("Calderwood & Harkness" or the "Firm") has been engaged to advise Ardent Capital Partners III LP ("Ardent Capital" or "Fund III") on state and local tax structuring matters in connection with Fund III's proposed acquisition of one hundred percent (100%) of the outstanding membership interests in Pinnacle Health Services Group LLC ("Pinnacle" or "PHSG"), a limited liability company organized under the laws of the State of Delaware and classified as a partnership for federal income tax purposes, at an aggregate enterprise value of approximately Four Hundred Twelve Million Dollars ($412,000,000) (the "Transaction"). The Transaction was executed by the parties on March 15, 2024, and closing is anticipated to occur on or about May 31, 2024, subject to satisfaction of customary closing conditions including applicable regulatory approvals.
The purpose of this letter is to summarize our five principal state and local tax ("SALT") optimization recommendations for the post-acquisition entity structure, following the detailed analysis set forth in our State & Local Tax Memorandum dated February 20, 2024 (the "SALT Memorandum"), our Preliminary Tax Structure Memorandum dated February 12, 2024, and our blocker Entity Analysis Memorandum dated February 16, 2024. This letter is intended to provide Ardent Capital's deal team and its co-counsel at Harcourt Shaw & DeVries LLP with a concise, actionable summary of the recommended SALT strategies, together with the operational and structural steps required to implement those strategies in connection with and following the closing of the Transaction.
The post-acquisition structure under analysis in this letter is as follows:
• Ardent Healthcare Holdings LLC (a Delaware limited liability company, classified as a partnership for federal income tax purposes; EIN 93-2187445) ("Holdings LLC"), which serves as the equity aggregation vehicle for the Transaction;
• Ardent Healthcare Intermediate Inc. (a Delaware C-corporation; EIN 93-2187512) ("Intermediate Inc."), which is interposed between Holdings LLC and the operating subsidiary and serves as the corporate blocker entity; and
• Pinnacle Health Services Group LLC (the surviving entity in the reverse merger of Ardent Healthcare Merger Sub LLC with and into Pinnacle; Delaware LLC; partnership tax status retained post-merger) ("Pinnacle" or "PHSG").
Pinnacle currently operates thirty-four (34) urgent care clinics and eight (8) ambulatory surgery centers, for a total of forty-two (42) healthcare facilities, across five states: the Commonwealth of Pennsylvania, the Commonwealth of Virginia, the State of Maryland, the State of North Carolina, and the State of Georgia. Pinnacle employs approximately 1,620 individuals, including 142 employed physicians. For the fiscal year ended December 31, 2023, Pinnacle reported revenue of approximately $287.4 million and Adjusted EBITDA of approximately $51.8 million, as verified by the quality of earnings analysis conducted by Northmark Advisory Group LLC.
This letter presents our five principal SALT optimization recommendations. Each recommendation is discussed in detail below, together with the legal and factual basis for the recommendation, the relevant state-by-state analysis, implementation steps, and coordination requirements with the broader deal team, including Harcourt Shaw & DeVries LLP (M&A counsel), Caldwell Pratt & Moorehouse LLP (Ardent Capital's accounting firm), Brewer Stanfield & Associates LLP (Pinnacle's existing accounting firm), and Whitford & Gaines LLP (sellers' counsel).
II. Overview of Post-Acquisition Entity Structure and Tax Classification
A thorough understanding of the post-acquisition entity structure and the tax classification of each entity is essential to the SALT analysis that follows. This section provides an overview of the three-tier entity structure and the composition of the investor base at each level.
A. Ardent Healthcare Holdings LLC
Holdings LLC is a Delaware limited liability company that has not filed a check-the-box election under Treasury Regulations Section 301.7701-3 and is accordingly classified as a partnership for federal income tax purposes by virtue of its default multi-member LLC classification. Holdings LLC serves as the equity aggregator for the Transaction, holding interests in Intermediate Inc. and facilitating the flow of distributions, income allocations, and tax benefits to its members.
The capitalization of Holdings LLC is anticipated to consist of the following equity interests:
• Fund III Committed Equity: $198,500,000, representing the committed equity capital contribution from Ardent Capital Partners III LP;
• Rollover Equity from Existing Pinnacle Management: Rollover equity contributions totaling $59,540,000, consisting of (i) $32,410,000 from Dr. Raymond Carvallo, Pinnacle's co-founder and Chief Medical Officer, (ii) $24,180,000 from Dr. Nadia Ostrowski, Pinnacle's co-founder and Chief Executive Officer, and (iii) $2,950,000 from Jonathan Farnsworth, Pinnacle's Chief Financial Officer; and
• Management Incentive Equity (Class B Units): Profits interests issued to continuing management participants, subject to the terms of the Amended and Restated Limited Liability Company Agreement of Holdings LLC.
In addition, Cascadia Mezzanine Fund IV LP, which serves as the mezzanine lender in the Transaction's capital structure, holds warrants representing 2.5% of the fully diluted equity of Holdings LLC, exercisable in accordance with the terms of the Warrant Agreement dated as of the closing date.
B. Ardent Healthcare Intermediate Inc.
Intermediate Inc. is a Delaware C-corporation interposed between Holdings LLC and the operating subsidiary. Intermediate Inc. holds 100% of the surviving Pinnacle entity's membership interests and is the direct owner of the operating business. As a C-corporation, Intermediate Inc. is subject to federal corporate income tax at the rate of 21% under Section 11 of the Internal Revenue Code, as well as corporate-level state income taxes in each state where it is nexused by virtue of Pinnacle's operations. Intermediate Inc.'s role in the structure is critical to the SALT analysis, as discussed in Recommendation 1 below.
C. Pinnacle Health Services Group LLC
Pinnacle is the surviving entity following the reverse merger of Ardent Healthcare Merger Sub LLC with and into Pinnacle. Pinnacle retains its classification as a partnership for federal income tax purposes and continues to operate the thirty-four urgent care clinics and eight ambulatory surgery centers across Pennsylvania, Virginia, Maryland, North Carolina, and Georgia. Post-closing, Pinnacle's sole member for tax purposes will be Intermediate Inc., but Pinnacle will continue to file federal partnership returns (Form 1065) and issue Schedule K-1s to its members.
D. Relevance to SALT
The relevance of this three-tier structure to the SALT analysis is substantial. State tax treatment of each entity depends on each state's classification rules, entity-level taxes, and nexus standards. Specifically:
• The classification of Holdings LLC and Pinnacle as partnerships at the federal level generally carries through to most operating states, meaning that income of those entities flows through to their respective members for state income tax purposes;
• The interposition of Intermediate Inc. as a C-corporation creates a corporate-level taxpayer that bears state income tax in each operating state, effectively serving as a "Blocker" that prevents flow-through income from reaching Holdings LLC and its individual members;
• The multi-state operating footprint of Pinnacle creates filing obligations, nexus considerations, and apportionment complexities that must be managed carefully to optimize the structure's state tax efficiency; and
• The presence of individual rollover participants (Carvallo, Ostrowski, and Farnsworth) as indirect owners through Holdings LLC creates sensitivity to state tax treatment of nonresident partners, pass-through entity elections, and withholding obligations.
The three-tier structure, when properly implemented and maintained, creates significant opportunities for state tax optimization, each of which is addressed in the recommendations that follow.
III. Recommendation 1: Blocker Entity Positioning for State Nexus Isolation
A. Role of Ardent Healthcare Intermediate Inc. as Nexus Shield
Our first and most fundamental SALT recommendation is the maintenance and proper operation of Intermediate Inc. as the direct owner of Pinnacle's membership interests, thereby creating a corporate-level "nexus shield" that isolates state income tax filing obligations at the Intermediate Inc. level and prevents those obligations from flowing through to Holdings LLC and its members.
By interposing Intermediate Inc. between Holdings LLC and Pinnacle, the post-acquisition structure ensures that corporate income tax filing obligations arise at the Intermediate Inc. level in each state where Pinnacle operates. Because Intermediate Inc. is a C-corporation, it is treated as a separate taxpayer in each operating state, and the income earned by Pinnacle flows through to Intermediate Inc. (as Pinnacle's sole member) and is taxed at the corporate level in each operating state. This structure shields Holdings LLC, and by extension its members — including Fund III, the rollover participants, the Class B Unit holders, and Cascadia Mezzanine Fund IV LP — from direct filing obligations in the operating states.
Without the blocker entity, Pinnacle's income would flow through directly to Holdings LLC, which would in turn flow through to its members. This would create individual-level filing obligations for the rollover participants (Carvallo, Ostrowski, and Farnsworth) in each of the five operating states, as well as potential filing obligations for Fund III and its limited partners. The interposition of Intermediate Inc. eliminates this cascade of filing obligations and consolidates state income tax compliance at the corporate level.
Our state-by-state nexus analysis for Intermediate Inc. is summarized below:
Pennsylvania. Pennsylvania imposes a corporate net income tax at a rate of 8.99% for the 2024 tax year. Under legislation enacted in 2022, this rate is scheduled to decline by approximately one-half percentage point per year, reaching 4.99% by 2031. Intermediate Inc. will be nexused in Pennsylvania by virtue of Pinnacle's operation of facilities in the Commonwealth and will file Pennsylvania corporate tax returns (Form RCT-101) annually. Pennsylvania's corporate net income tax is a significant component of the overall state tax burden on the structure, but the declining rate schedule creates increasing state tax efficiency over the projected investment horizon.
Virginia. Virginia imposes a corporate income tax at a flat rate of 6.0%. Intermediate Inc. will be subject to Virginia corporate income tax filing obligations based on Pinnacle's operation of facilities within the Commonwealth. Virginia also imposes a minimum tax and various local business license taxes, which should be evaluated on a facility-by-facility basis during post-closing compliance integration.
Maryland. Maryland imposes a corporate income tax at a rate of 8.25%. Intermediate Inc. will be nexused in Maryland and will be required to file Maryland corporate income tax returns (Form 500) based on Pinnacle's Maryland operations. Maryland's relatively high corporate rate makes it one of the more significant state tax jurisdictions for the structure and underscores the importance of the Maryland PTE election discussion in Recommendation 2 below.
North Carolina. North Carolina imposes a corporate income tax at a rate of 2.5% for the 2024 tax year, which is among the lowest corporate income tax rates in the nation. In addition, North Carolina imposes a franchise tax on corporations doing business in the state, calculated based on the greater of capital stock, surplus, and undivided profits or 55% of the appraised value of property in North Carolina. Intermediate Inc. will be subject to both the corporate income tax and franchise tax in North Carolina.
Georgia. Georgia imposes a corporate income tax at a rate of 5.75%. Intermediate Inc. will be subject to Georgia corporate income tax filing obligations based on Pinnacle's operations within the state. Georgia also imposes a net worth tax on corporations, with rates ranging from $10 to $5,000 annually depending on net worth.
Based on the foregoing state-by-state analysis and Pinnacle's revenue and EBITDA allocation across operating states, we estimate the blended effective state tax rate applicable to Intermediate Inc. across all five operating states at approximately 6.42%, weighted by EBITDA allocation. This blended rate serves as the basis for the state tax component of the TRA benefit calculations discussed in Section IX below.
B. Apportionment Methodology Considerations
The apportionment methodology employed by each operating state has a meaningful impact on the effective state tax rate borne by Intermediate Inc. and should be considered in evaluating the overall efficiency of the blocker entity structure.
Pennsylvania, Virginia, and Georgia each use a single-sales-factor apportionment methodology for corporate income tax purposes. Under single-sales-factor apportionment, the share of a taxpayer's income apportioned to the taxing state is determined solely by the ratio of the taxpayer's sales sourced to that state relative to its total sales everywhere. This methodology favors the structure because Pinnacle's revenue is concentrated in its operating states and no sales are sourced to Delaware, the state of incorporation of Intermediate Inc. As a result, Intermediate Inc. will not be subject to income tax on any portion of its income in Delaware by virtue of sales apportionment alone.
Maryland and North Carolina use a three-factor apportionment formula, consisting of property, payroll, and sales factors, with the sales factor double-weighted. While this methodology considers the location of property and payroll in addition to sales, the double-weighting of the sales factor ensures that sales remain the dominant driver of apportionment in these states as well.
We recommend that Intermediate Inc. be operated as a holding company with minimal property and payroll in its own right. Specifically, Intermediate Inc. should not own or lease real property, maintain offices, or employ personnel. All operational activities should be conducted at the Pinnacle level (or by Ardent Capital GP III LLC under advisory agreements, as discussed in Recommendation 4). This operational discipline ensures that apportionment is driven primarily by Pinnacle's operating footprint and minimizes any apportionment overlap or throwback risk in Delaware.
C. Delaware Considerations for Intermediate Inc.
As a Delaware C-corporation, Intermediate Inc. is subject to certain Delaware-specific tax obligations that should be managed to minimize unnecessary tax costs. Delaware does not impose a corporate income tax on holding companies that do not conduct business within the state. Because Intermediate Inc. will function solely as a holding company for Pinnacle's membership interests and will not conduct operations, maintain employees, or engage in commercial activities within Delaware, Intermediate Inc. should not be subject to Delaware corporate income tax.
However, Delaware imposes a franchise tax on all corporations organized under Delaware law. The franchise tax is calculated using one of two methods: (i) the authorized shares method or (ii) the assumed par value capital method. The authorized shares method can result in a franchise tax liability of up to $200,000 per year for corporations with a large number of authorized shares, while the assumed par value capital method often produces a lower tax liability for corporations with substantial capital.
Recommendation: The authorized share count and par value of Intermediate Inc.'s capital stock should be structured to minimize the Delaware franchise tax liability. We recommend consulting with Harcourt Shaw & DeVries LLP to confirm that the certificate of incorporation authorizes a number of shares and par value that produces an optimal result under the assumed par value capital method, targeting an annual Delaware franchise tax liability of no more than $50,000.
IV. Recommendation 2: Maryland Pass-Through Entity Tax Election
A. Background on Maryland PTE Election
Maryland enacted a pass-through entity ("PTE") tax election, codified at Tax-General Article § 10-102.1 of the Annotated Code of Maryland, which permits eligible pass-through entities conducting business in Maryland to elect to pay income tax at the entity level on behalf of their resident and nonresident members. The PTE tax is calculated based on the entity's Maryland-source income and is imposed at a rate equal to the highest marginal individual income tax rate for Maryland residents (currently 5.75% state rate, plus the local income tax rate applicable to the entity's principal office or the highest local rate if the entity has no principal office in Maryland, yielding a combined rate of approximately 8.25% for most entities).
The critical feature of the Maryland PTE election for purposes of the Transaction is that the PTE tax paid at the entity level is deductible against federal taxable income at the entity level. This deductibility effectively circumvents the $10,000 annual limitation on the deduction of state and local taxes imposed on individual taxpayers under Section 164(b)(6) of the Internal Revenue Code (commonly known as the "SALT Cap"), which was enacted as part of the Tax Cuts and Jobs Act of 2017 and is currently scheduled to remain in effect through December 31, 2025 (although its extension or modification remains the subject of ongoing legislative discussion at the federal level).
By paying state income tax at the entity level rather than requiring individual members to pay such tax on their individual returns, the PTE election converts what would otherwise be a non-deductible (or limited-deductibility) state tax payment into a fully deductible business expense at the entity level, producing a net federal tax benefit for individual members whose state and local tax deductions would otherwise be limited by the SALT Cap.
B. Application to the Transaction
Pinnacle operates healthcare facilities in Maryland and will continue to generate Maryland-source income both before and after the closing of the Transaction. The Maryland PTE election is relevant to the Transaction in two distinct time periods:
Pre-Closing (Short Tax Year Ending May 31, 2024). Pinnacle will file a short-period partnership tax return for the period beginning January 1, 2024 and ending May 31, 2024 (the anticipated closing date), reflecting the final period during which the pre-closing owners held their membership interests in Pinnacle. During this period, Pinnacle's members include both the rollover participants (Carvallo, Ostrowski, and Farnsworth) and the fourteen (14) minority physician-investors who are receiving cash-out proceeds and will not be rolling over into the post-closing structure. To the extent these individuals have Maryland-source income from Pinnacle during the short tax year, they would benefit from the PTE election because the entity-level tax payment would be deductible at the entity level for federal tax purposes, effectively bypassing the SALT Cap limitation that would otherwise apply to their individual state tax payments.
Post-Closing (Ongoing Operations). Following closing, the ownership structure of Pinnacle changes materially. Intermediate Inc., a C-corporation, will become Pinnacle's sole member. Because C-corporations are not subject to the SALT Cap (the SALT Cap applies only to individual taxpayers), the PTE election has diminished relevance at the Pinnacle level post-closing. However, to the extent any pass-through entities in the broader structure — including Holdings LLC — have individual members with Maryland-source income, the PTE election should be evaluated annually. The rollover participants (Carvallo, Ostrowski, and Farnsworth) hold interests in Holdings LLC, which is a partnership. If Holdings LLC is allocated Maryland-source income (for example, through its indirect ownership of Pinnacle via Intermediate Inc.), the rollover participants could potentially benefit from a PTE election at the Holdings LLC level, subject to the specific application of Maryland's PTE rules to tiered partnership structures. This analysis should be coordinated with Caldwell Pratt & Moorehouse LLP on an annual basis.
C. Recommendation
1. Short Tax Year PTE Election. Pinnacle should make the Maryland PTE election for its short tax year ending May 31, 2024, to benefit the individual sellers (both the fourteen minority physician-investors receiving cash-out proceeds and the three rollover participants with respect to their pre-closing allocable share of Maryland-source income). The election should be made on a timely basis in accordance with the procedures prescribed by the Comptroller of Maryland.
2. Post-Closing Annual Evaluation. Following closing, Ardent Capital should coordinate with Caldwell Pratt & Moorehouse LLP to evaluate the Maryland PTE election annually for any pass-through entities in the structure that have individual members with Maryland-source income. This analysis should consider the continuing applicability of the SALT Cap at the federal level, any changes to Maryland's PTE election statute, and the specific allocation of Maryland-source income within the tiered entity structure.
3. Coordination with Sellers' Counsel. The PTE election for the short tax year should be communicated to Whitford & Gaines LLP (Patricia Engelman) so that the individual sellers are aware of the election and can properly account for the entity-level tax payment on their individual Maryland and federal income tax returns.
Note: Because Intermediate Inc. is a C-corporation, the PTE election is most directly relevant at the Pinnacle level during the pre-closing period and at the Holdings LLC level to the extent Holdings LLC has individual members with Maryland-source income post-closing. The interaction between the PTE election and the tiered partnership structure should be monitored carefully, as Maryland's PTE rules are subject to administrative guidance that may evolve over time.
V. Recommendation 3: Philadelphia Business Income and Receipts Tax (BIRT) Mitigation
A. Exposure
Pinnacle currently operates three (3) urgent care clinics within the City of Philadelphia, Pennsylvania. The operation of these facilities subjects Pinnacle (and, post-closing, Intermediate Inc. as Pinnacle's corporate-level taxpayer in Pennsylvania) to the Philadelphia Business Income and Receipts Tax ("BIRT"), which is administered by the City of Philadelphia Department of Revenue.
The BIRT is a two-component tax imposed on all businesses operating within the City of Philadelphia:
• Gross Receipts Tax Component: A tax imposed at a rate of 0.1415 mills (i.e., $1.415 per $1,000 of Philadelphia gross receipts, or approximately 0.1415%) on the gross receipts attributable to business activity conducted within the City of Philadelphia. This component is imposed on gross revenue, not net income, and therefore cannot be reduced by deductions for operating expenses. For the three Philadelphia clinics, which generated approximately $22.6 million in combined revenue for the 2023 fiscal year, the gross receipts tax component represents a liability of approximately $31,979 annually at current rates.
• Net Income Tax Component: A tax imposed at a rate of 5.99% on the net income apportioned to the City of Philadelphia under the city's apportionment rules. The net income component is a more significant source of tax liability and is calculated based on the taxpayer's net income multiplied by an apportionment fraction determined using the city's apportionment methodology, which considers the ratio of the taxpayer's Philadelphia-based business activity relative to its total business activity.
The BIRT applies in addition to the Pennsylvania corporate net income tax, creating a "stacking" effect that increases the effective tax burden on income generated by the Philadelphia clinics. When combined with the Pennsylvania corporate net income tax rate of 8.99% (for 2024), the Philadelphia BIRT net income component of 5.99% results in a combined state and city effective tax rate on Philadelphia-source income of approximately 14.98%, before accounting for the gross receipts tax component. This is materially higher than the blended effective state rate of 6.42% applicable to the structure's overall income and warrants careful attention.
B. Mitigation Strategies
We have identified several potential strategies for mitigating the Philadelphia BIRT exposure:
Operational Restructuring. An evaluation should be conducted to determine whether any administrative or management functions currently performed at or attributed to the three Philadelphia clinics can be relocated outside the city limits. Pinnacle's corporate headquarters is located at 2200 Renaissance Boulevard, Suite 400, King of Prussia, Pennsylvania 19406, which is situated in Montgomery County, outside the City of Philadelphia. To the extent that management services, billing and coding functions, administrative support, and other non-clinical activities can be centralized at the King of Prussia headquarters (or at other non-Philadelphia locations), the revenue and income attributable to the Philadelphia clinics for BIRT apportionment purposes may be reduced.
Subsidiary Restructuring. Consideration should be given to whether the creation of a separate legal entity — a Philadelphia-only operating subsidiary under Pinnacle — could limit the BIRT exposure to only the income and gross receipts of the three Philadelphia clinics, preventing the BIRT from being calculated on a broader revenue or income base. Under such a structure, the Philadelphia subsidiary would be the only entity subject to the BIRT, and the BIRT apportionment fraction would be applied solely to that entity's income and receipts. This strategy must be evaluated carefully to ensure that it is respected by the Philadelphia Department of Revenue under economic substance and anti-avoidance doctrines.
Apportionment Review. A detailed review should be conducted to ensure that revenue and income from non-Philadelphia clinics (including the additional Pennsylvania clinics located outside the city) is not inadvertently sourced to Philadelphia under the city's apportionment rules. The Philadelphia BIRT apportionment methodology can produce unexpected results if intercompany transactions, shared services, or cost allocation arrangements create artificial connections between Philadelphia and non-Philadelphia operations. Proper documentation and cost center separation are essential to an accurate apportionment calculation.
Long-Term Rate Monitoring. The City of Philadelphia has periodically adjusted BIRT rates, and the net income component has been on a declining trajectory in recent years. Future rate reductions may reduce the economic urgency of a restructuring. However, given the magnitude of the combined state and city tax burden on Philadelphia-source income, proactive mitigation efforts remain prudent regardless of potential rate reductions.
C. Recommendation
1. Near Term. Ensure strict cost center separation for the three Philadelphia clinics and proper documentation of revenue sourcing. All management fees, shared services charges, and cost allocations between Philadelphia and non-Philadelphia operations should be documented and supportable under the city's apportionment rules. This should be implemented promptly following closing.
2. Medium Term. Evaluate the cost-benefit of creating a Philadelphia-only operating subsidiary under Pinnacle. This analysis should consider the incremental legal and administrative costs of maintaining a separate entity, the tax savings achievable through BIRT isolation, and the risk of challenge by the Philadelphia Department of Revenue. We recommend that this evaluation be completed within twelve (12) months following closing.
3. Coordination. During the transition period between signing and closing, and for the initial post-closing compliance period, coordinate with Brewer Stanfield & Associates LLP (Pinnacle's existing accounting firm) for Philadelphia BIRT return preparation and apportionment analysis. Post-transition, responsibility for BIRT compliance should be assumed by Caldwell Pratt & Moorehouse LLP.
VI. Recommendation 4: New York Nexus Avoidance for Ardent Healthcare Holdings LLC
A. Risk Identified
A significant risk identified in our SALT analysis relates to the potential creation of New York nexus for Holdings LLC. Holdings LLC's management activities could create New York nexus if management services are provided from, or directed at Holdings LLC from, Ardent Capital's offices at 600 Lexington Avenue, 38th Floor, New York, New York 10022.
New York imposes income tax on limited liability companies and partnerships that have sufficient nexus with the state. Under New York Tax Law § 631(b)(1)(A) and applicable regulations, a partnership is treated as "doing business" in New York if it maintains an office, has employees, or otherwise conducts regular, systematic, and continuous business activity within the state. If Holdings LLC were found to be "doing business" in New York, it would be required to file a New York partnership return (Form IT-204), and its members — including the individual rollover participants (Carvallo, Ostrowski, and Farnsworth) — could be subject to New York income tax on their allocable share of Holdings LLC's New York-apportioned income, regardless of whether those individuals are New York residents.
This risk is particularly significant because Holdings LLC is the equity aggregation vehicle holding interests in Intermediate Inc. and would have significant investment income (dividends and gains from Intermediate Inc.), TRA-related cash flows, management fee income (if Holdings LLC were improperly made a party to management services arrangements), and other income items. If Holdings LLC were treated as doing business in New York, the resulting tax exposure could be substantial, undermining the nexus isolation benefits of the blocker entity structure described in Recommendation 1.
B. Structural Mitigation — Management Fee Agreement Routing
The key mitigation strategy is to ensure that the management fee agreements, advisory services agreements, and monitoring agreements associated with the Transaction are structured to avoid creating New York nexus for Holdings LLC. Specifically:
• Management fee and advisory services agreements should be entered into between Ardent Capital GP III LLC (the general partner of Fund III, which is already nexused in New York and filing New York returns as part of its ordinary course business activities) and Ardent Healthcare Intermediate Inc. Under this arrangement, Ardent Capital GP III LLC provides management, monitoring, and advisory services to Intermediate Inc. (and, indirectly, to Pinnacle) in exchange for annual management fees. These fees are paid by Intermediate Inc. and are deductible at the corporate level for both federal and state income tax purposes.
• Holdings LLC should NOT be a party to any management services agreement, advisory agreement, monitoring agreement, or similar arrangement. Holdings LLC should not directly employ personnel, maintain offices or other physical presence in New York, or engage in any active management, monitoring, or oversight functions with respect to Pinnacle or any other portfolio company.
• Holdings LLC's registered office is c/o Pemberton Industries, 251 Little Falls Drive, Wilmington, Delaware 19808, and its business activities should be strictly limited to the passive holding of Intermediate Inc. equity, the receipt of distributions from Intermediate Inc., and the making of distributions to its members. Holdings LLC should not engage in any activities that could be characterized as conducting business in New York or any other state other than Delaware.
• All active management, monitoring, and oversight functions with respect to Pinnacle should be performed by Ardent Capital GP III LLC (or Fund III itself) under advisory agreements with Intermediate Inc. This routing ensures that the management activities conducted from Ardent Capital's New York offices are attributed to Ardent Capital GP III LLC — an entity that is already filing New York returns and managing its New York tax obligations — rather than to Holdings LLC.
C. Operational Safeguards
To ensure the effectiveness of the New York nexus avoidance strategy, the following operational safeguards should be implemented and maintained on an ongoing basis:
• Holdings LLC should not have any employees in New York or in any other state. If administrative functions are required for Holdings LLC (e.g., bookkeeping, annual return preparation), those functions should be performed by third-party service providers located outside New York.
• Holdings LLC should not maintain any office space in New York. Holdings LLC should not be listed on the lease for Ardent Capital's offices at 600 Lexington Avenue, nor should any workspace, mailbox, telephone line, or other facility at those offices be attributed to Holdings LLC.
• Holdings LLC should not maintain any bank accounts in New York. Any bank accounts required for Holdings LLC's limited activities (receipt of distributions, payment of expenses, and distributions to members) should be maintained at financial institutions located in Delaware or another jurisdiction outside New York.
• Board meetings or member meetings of Holdings LLC should be held outside New York. We recommend that such meetings be held in Delaware (at Pemberton Industries's offices or another location in Wilmington) or at Pinnacle's headquarters in King of Prussia, Pennsylvania, or another neutral jurisdiction. If telephonic or video meetings are conducted, the record of such meetings should reflect that the meeting was called from and conducted outside New York.
• Holdings LLC's books and records should be maintained at its registered office in Wilmington, Delaware, or at Pinnacle's headquarters in King of Prussia, Pennsylvania. Books and records should not be physically located at Ardent Capital's New York offices.
• All correspondence and tax filings for Holdings LLC should use the Delaware registered office address. Under no circumstances should Holdings LLC's address be listed as 600 Lexington Avenue, New York, New York.
• Periodic review of Holdings LLC's activities should be conducted at least annually to confirm that no inadvertent nexus-creating activities have occurred. This review should be documented and maintained as part of Holdings LLC's compliance records.
D. Recommendation
1. Execute the Management Fee/Advisory Agreement between Ardent Capital GP III LLC and Ardent Healthcare Intermediate Inc. prior to or contemporaneously with the closing of the Transaction. The agreement should be reviewed by Harcourt Shaw & DeVries LLP (Thomas Kundra) to ensure that the terms are consistent with the nexus avoidance strategy and that Holdings LLC is not named as a party or referenced as providing services.
2. Adopt a Written Holdings LLC Nexus Avoidance Policy and Checklist. We recommend that Ardent Capital's deal team adopt a formal written policy governing Holdings LLC's activities and a compliance checklist to be completed at least annually by the individual(s) responsible for Holdings LLC's administration. A template for this policy and checklist can be provided by our office upon request.
3. Coordinate with Harcourt Shaw & DeVries LLP. Thomas Kundra and his team should review all organizational documents, operating agreements, management fee agreements, and advisory agreements to ensure consistency with the nexus avoidance structure. In particular, the Amended and Restated Limited Liability Company Agreement of Holdings LLC should not contain provisions that could be interpreted as authorizing Holdings LLC to engage in active business operations in New York.
VII. Recommendation 5: State Nonresident Withholding Management
A. Withholding Obligations on Sellers
Several of the states in which Pinnacle operates impose withholding obligations on the disposition of interests in entities conducting business within the state by nonresident individuals. These withholding obligations are imposed on the entity (or the buyer, in certain states) and require the payment to the state taxing authority of a specified percentage of the gain apportioned to the state on behalf of nonresident sellers.
Based on our analysis of the Transaction's gain allocation and the applicable state withholding rules, the estimated withholding obligations on the individual sellers of Pinnacle membership interests at closing are as follows:
These amounts represent preliminary estimates based on the gain allocation methodology set forth in the purchase agreement and the apportionment of gain to each state based on the geographic distribution of Pinnacle's operations. Final amounts will be determined in the Nonresident Withholding Computation Schedule, which is expected to be delivered on or about May 15, 2024.
State-Specific Notes:
• Pennsylvania. The Commonwealth of Pennsylvania does not impose a nonresident withholding obligation on sales of partnership interests. Accordingly, no Pennsylvania withholding is required at closing.
• North Carolina. The North Carolina withholding analysis remains subject to confirmation. North Carolina may require withholding at a rate of 5.25% on North Carolina-source gain for nonresident sellers of interests in entities conducting business in the state. This analysis is expected to be finalized in the Nonresident Withholding Computation Schedule. If North Carolina withholding is required, it would increase the aggregate withholding amount above $4.74 million.
• Virginia, Maryland, and Georgia. Withholding in these states is required and the amounts set forth above will be deducted from seller proceeds at closing and remitted to the respective state tax authorities in accordance with each state's filing requirements.
B. Coordination with Closing Funds Flow
The withholding amounts described above will be deducted from the aggregate equity consideration of $339,400,000 payable to the selling members of Pinnacle at closing. The withholding amounts should be reflected as separate line items in the closing statement and funds flow memorandum prepared by Harcourt Shaw & DeVries LLP.
Coordination with the following parties is required to ensure proper treatment of withholding amounts in the closing funds flow:
• Ironbridge Trust Company, N.A. (escrow agent; Wilmington, Delaware; Escrow Agreement Reference No. ITC-ESC-2024-05312): The escrow agreement should be reviewed to confirm that the withholding amounts are excluded from the escrow deposit and are instead directed to the appropriate state tax authorities or held in a segregated account for remittance.
• Graystone National Bank, N.A. (administrative agent under the credit agreement): Coordination with the administrative agent is required to ensure that the withholding amounts are properly deducted from the equity consideration before the remaining net proceeds are distributed to sellers.
• Sellers. Each individual seller should receive a detailed statement showing the amount withheld on their behalf for each applicable state. Sellers will be entitled to claim credit for the withheld amounts on their individual state income tax returns for the applicable tax year (i.e., the tax year in which the closing occurs). The credits should offset or eliminate the sellers' individual state income tax liability on the gain from the Transaction, to the extent the withholding amounts equal or exceed their actual state tax liability.
C. Recommendation
1. Include State Withholding Line Items in the Closing Statement and Funds Flow. Harcourt Shaw & DeVries LLP should include separate line items for Virginia, Maryland, and Georgia (and North Carolina, if applicable) nonresident withholding in the closing statement and funds flow memorandum. These line items should identify the aggregate withholding amount for each state and the allocation of withholding among the individual sellers.
2. Coordinate with Sellers' Counsel. Whitford & Gaines LLP (Patricia Engelman) should be notified of the withholding amounts so that the individual sellers are aware of the amounts to be withheld from their proceeds and can plan their individual state and federal income tax filings accordingly. Each seller should receive a copy of the withholding certificate or receipt issued by the applicable state taxing authority.
3. File Withholding Returns Promptly After Closing. Withholding returns should be filed in Virginia, Maryland, and Georgia promptly after closing, in accordance with each state's filing deadlines. In most states, withholding returns are due within thirty (30) days of the closing date or by the fifteenth day of the month following the month in which closing occurs, whichever is later. We recommend that Caldwell Pratt & Moorehouse LLP be engaged to prepare and file these returns.
VIII. Post-Closing State Tax Compliance Calendar
The following summarizes the post-closing state tax filing obligations for each entity in the post-acquisition structure. This summary is intended to serve as a compliance reference for Ardent Capital's deal team and its accounting advisors at Caldwell Pratt & Moorehouse LLP.
A. Ardent Healthcare Intermediate Inc.
• Corporate income tax returns are required in each of the five operating states: Pennsylvania (Form RCT-101), Virginia (Form 500), Maryland (Form 500), North Carolina (Form CD-405), and Georgia (Form 600).
• Delaware franchise tax return is required annually, due on or before March 1 of each year for the preceding calendar year. The Delaware franchise tax should be calculated using the assumed par value capital method, as discussed in Recommendation 1.
• Intermediate Inc.'s fiscal year for state and federal tax purposes is the calendar year (January 1 through December 31). For the initial post-closing year (2024), a full-year return will be filed reflecting operations from the closing date (anticipated May 31, 2024) through December 31, 2024.
B. Pinnacle Health Services Group LLC
• Partnership/information returns are required in each operating state, as well as a federal partnership return (Form 1065). State partnership returns will be filed in Pennsylvania, Virginia, Maryland, North Carolina, and Georgia.
• Schedule K-1s will be issued to Pinnacle's members (primarily Intermediate Inc., as Pinnacle's sole member post-closing).
• Section 754 Election. A Section 754 election will be filed with Pinnacle's federal Form 1065 for the taxable year ending December 31, 2024, producing a Section 743(b) basis step-up of approximately $224.4 million for Intermediate Inc. (as discussed in Section IX below). The Section 754 election must be properly documented and attached to the timely filed (including extensions) partnership return.
C. Ardent Healthcare Holdings LLC
• Partnership/information returns are required at the federal level (Form 1065). State partnership filings should be limited to Delaware (Form 300) and any other states where nexus is established. The objective of Recommendation 4 is to avoid nexus outside Delaware. If the nexus avoidance strategy is properly implemented, Holdings LLC should not be required to file state partnership returns in any state other than Delaware.
• Schedule K-1s will be issued to Holdings LLC's members, including Fund III, the rollover participants (Carvallo, Ostrowski, and Farnsworth), the Class B Unit holders, and Cascadia Mezzanine Fund IV LP.
D. Rollover Participants
• Dr. Raymond Carvallo, Dr. Nadia Ostrowski, and Jonathan Farnsworth will have individual state income tax return filing obligations in states where Holdings LLC or Pinnacle has nexus, depending on each state's rules for taxing nonresident partners. If the nexus avoidance strategy for Holdings LLC is successfully implemented, the rollover participants' state filing obligations should be limited to their states of residence and, potentially, Delaware (to the extent Delaware imposes filing obligations on nonresident partners of Delaware partnerships, which is generally limited).
• The rollover participants should be advised to consult with their personal tax advisors regarding their individual state income tax obligations arising from the Transaction and the ongoing operation of the structure.
E. Pennsylvania Rate Reduction Schedule
The Pennsylvania corporate net income tax rate reduction schedule, enacted in 2022, provides for annual rate reductions from 8.99% (2024) to 4.99% (2031), as follows:
This declining rate schedule creates increasing state tax efficiency over the projected investment horizon for Intermediate Inc.'s Pennsylvania corporate net income tax obligations and should be factored into financial projections and TRA benefit calculations.
F. Annual Review
We recommend that an annual review be conducted following closing to assess changes in state tax laws, rate adjustments, apportionment methodology updates, and new state tax developments that may affect the structure. This review should be coordinated with Caldwell Pratt & Moorehouse LLP and should include, at a minimum, a reassessment of the five recommendations set forth in this letter in light of then-current state tax law.
IX. Interaction with Federal Tax Elections and Tax Receivable Agreement
The SALT optimization strategies described in this letter are designed to complement the federal tax structuring decisions previously recommended by this Firm and endorsed by Ardent Capital's deal team. The interaction between the SALT strategies and the federal tax structure is summarized below.
A. Section 754 Election and Section 743(b) Basis Step-Up
Pinnacle will make an election under Section 754 of the Internal Revenue Code for the taxable year ending December 31, 2024. This election, in conjunction with the acquisition of Pinnacle's membership interests by Intermediate Inc. in the Transaction, will produce a Section 743(b) basis step-up for Intermediate Inc. in the amount of approximately $224,400,000, calculated as the difference between the aggregate enterprise value of $412,000,000 and Pinnacle's inside tax basis of approximately $187,600,000.
The Section 743(b) basis step-up will be allocated among Pinnacle's assets in accordance with the rules of Section 755 of the Internal Revenue Code, producing annual amortization and depreciation deductions for Intermediate Inc. The weighted-average useful life of the stepped-up basis, taking into account the allocation among intangible assets (customer relationships, tradenames, non-compete agreements, workforce in place, and goodwill) and tangible assets (medical equipment, leasehold improvements, and other fixed assets), is estimated at approximately 11.2 years.
This produces an estimated annual amortization deduction of approximately $20,040,000 ($224,400,000 ÷ 11.2 years), which reduces Pinnacle's taxable income allocable to Intermediate Inc. and produces an estimated annual federal and state tax benefit of approximately $5,010,000 at a blended federal/state tax rate of approximately 25%.
B. Tax Receivable Agreement
Under the Tax Receivable Agreement (the "TRA") to be entered into among Intermediate Inc., Holdings LLC, and the rollover participants and pre-closing members, 85% of the realized tax benefits attributable to the Section 743(b) basis step-up (including both federal and state tax benefits) will be payable to the rollover participants and pre-closing members. The estimated annual TRA payment is approximately $4,260,000 (85% × $5,010,000).
The blended 25% tax rate used in the TRA benefit computation incorporates both the federal corporate income tax rate of 21% and the blended effective state income tax rate of 6.42%, accounting for the federal deductibility of state income taxes. The blended rate is computed as follows:
Blended Rate = Federal Rate + State Rate × (1 - Federal Rate) Blended Rate = 21.00% + 6.42% × (1 - 0.21) Blended Rate = 21.00% + 5.07% Blended Rate ≈ 26.07%
Note: The 25% rate used in the TRA computations reflects a rounded estimate; the precise rate will be updated annually based on actual effective state tax rates and the Pennsylvania rate reduction schedule.
C. State Conformity with Section 743(b) Step-Up
A critical element of the state tax analysis is whether the operating states conform to the federal partnership tax provisions governing the Section 754 election and Section 743(b) basis step-up. Our analysis confirms the following:
• Pennsylvania generally conforms to federal partnership tax provisions, including Sections 754 and 743(b). The Section 743(b) basis step-up should be recognized for Pennsylvania corporate net income tax purposes, producing amortization deductions that reduce Pinnacle's income allocable to Intermediate Inc. for Pennsylvania tax purposes.
• Virginia generally conforms to federal partnership tax provisions and recognizes the Section 743(b) basis step-up for state income tax purposes.
• Maryland generally conforms to federal partnership tax provisions and recognizes the Section 743(b) basis step-up for state income tax purposes.
• North Carolina generally conforms to federal partnership tax provisions and recognizes the Section 743(b) basis step-up for state income tax purposes.
• Georgia generally conforms to federal partnership tax provisions and recognizes the Section 743(b) basis step-up for state income tax purposes.
No material state decoupling issues have been identified with respect to the Section 754 election or Section 743(b) basis step-up in any of the five operating states. However, we recommend annual monitoring of each state's conformity provisions, as states periodically update their conformity dates and may decouple from specific federal provisions in future legislative sessions.
X. Summary of Recommendations
The following summarizes the five principal SALT optimization recommendations set forth in this letter:
1. blocker Entity Positioning. Maintain Ardent Healthcare Intermediate Inc. as the direct owner of Pinnacle's membership interests, isolating corporate-level state income tax filing obligations at the Intermediate Inc. level and shielding Holdings LLC and its members (including Fund III, the rollover participants, and the mezzanine lender) from multi-state nexus and individual-level filing obligations in the five operating states. Operate Intermediate Inc. as a holding company with minimal property and payroll to optimize apportionment. Structure authorized shares and par value to minimize Delaware franchise tax.
2. Maryland PTE Election. Pinnacle should make the Maryland pass-through entity tax election for its short tax year ending May 31, 2024, to benefit the individual sellers (including the fourteen minority physician-investors receiving cash-out proceeds and the three rollover participants). Post-closing, the PTE election should be evaluated annually in coordination with Caldwell Pratt & Moorehouse LLP for any pass-through entities in the structure that have individual members with Maryland-source income.
3. Philadelphia BIRT Mitigation. In the near term, ensure strict cost center separation for the three Philadelphia clinics and proper documentation of revenue sourcing to prevent BIRT apportionment from capturing non-Philadelphia revenue. In the medium term, evaluate the cost-benefit of creating a Philadelphia-only operating subsidiary under Pinnacle to isolate BIRT exposure. Coordinate with Brewer Stanfield & Associates LLP during the transition period.
4. New York Nexus Avoidance. Route management fee and advisory services agreements through Ardent Capital GP III LLC (an entity already nexused in New York) to Ardent Healthcare Intermediate Inc. Maintain Holdings LLC as a passive Delaware holding entity with no employees, office space, bank accounts, or other presence in New York. Adopt a written Holdings LLC nexus avoidance policy and compliance checklist. Coordinate with Harcourt Shaw & DeVries LLP to ensure organizational documents and agreements are consistent with this structure.
5. State Nonresident Withholding Management. Withhold and remit an estimated aggregate of $4,740,000 across Virginia ($1,460,000), Maryland ($2,410,000), and Georgia ($870,000) at closing. Include state withholding line items in the closing statement and funds flow. Coordinate with Whitford & Gaines LLP (sellers' counsel) to ensure sellers are aware of withholding amounts and can claim credits on their individual state income tax returns. File withholding returns in all applicable states promptly after closing.
XI. Limitations and Qualifications
This letter is provided solely for the benefit of Ardent Capital Partners III LP and its affiliates, including Ardent Healthcare Holdings LLC, Ardent Healthcare Intermediate Inc., and Ardent Capital GP III LLC, in connection with the Transaction described herein. This letter may not be relied upon by any other party, including any seller, any lender, any counterparty to the Transaction, or any governmental authority, without our prior written consent. This letter may be shared with Harcourt Shaw & DeVries LLP, Caldwell Pratt & Moorehouse LLP, and other advisors to Ardent Capital on a need-to-know basis, subject to the preservation of the attorney-client privilege and work product protections applicable to this communication.
The recommendations and analyses contained herein are based on state and local tax laws, regulations, administrative guidance, and judicial decisions in effect as of the date of this letter (March 18, 2024). State tax laws are subject to change by legislative action, administrative rulemaking, or judicial interpretation, and any such changes could materially affect the conclusions and recommendations set forth herein. We undertake no obligation to update this letter to reflect changes in applicable law occurring after the date hereof, although we recommend periodic review as described in Section VIII.F above.
Quantitative estimates contained in this letter, including the estimated blended effective state tax rate (6.42%), the estimated state nonresident withholding amounts ($4.74 million in the aggregate), the estimated annual amortization deduction ($20.04 million), and the estimated annual TRA payment ($4.26 million), are based on information provided by Ardent Capital, the quality of earnings analysis prepared by Northmark Advisory Group LLC, and Pinnacle's financial data as reviewed and reported by Brewer Stanfield & Associates LLP. These estimates are necessarily forward-looking and are based on assumptions regarding future operations, revenue levels, cost structures, and other factors that may differ materially from actual results. Actual state tax liabilities, withholding amounts, amortization deductions, and TRA payments may differ from the estimates set forth herein, and we make no representation or warranty regarding the accuracy or completeness of such estimates.
This letter does not constitute a formal tax opinion. A separate Tax Opinion Letter addressing the rollover equity tax-deferred treatment and other federal tax matters will be provided by this Firm in connection with the closing of the Transaction. The recommendations set forth herein are intended to inform Ardent Capital's decision-making regarding the post-acquisition entity structure and are not intended to provide assurance as to the tax consequences of any particular transaction, election, or filing position.
We recommend that the strategies outlined herein be reviewed periodically following closing, particularly in light of anticipated state tax rate changes (including the Pennsylvania corporate net income tax rate reduction schedule), potential federal legislation affecting the SALT Cap, evolving state administrative guidance on PTE elections, and any changes to state nexus standards or apportionment methodologies.
XII. Closing
We appreciate the opportunity to advise Ardent Capital Partners III LP on this important transaction and welcome any questions regarding these recommendations. We look forward to continuing to work with your team and your co-counsel at Harcourt Shaw & DeVries LLP as the Transaction proceeds toward closing.
Please do not hesitate to contact Leonard Cross or Sylvia Hartwell at the contact information below with any questions or to discuss any of the recommendations set forth in this letter in greater detail.
Very truly yours,
CALDERWOOD & HARKNESS LLP
By: ________
Leonard Cross Partner, Tax Calderwood & Harkness LLP Telephone: (212) 848-6142
Email: lcross@calderwoodharkness.com
By: ________
Sylvia Hartwell Partner, Tax Calderwood & Harkness LLP Telephone: (212) 848-6278
Email: shartwell@calderwoodharkness.com
Calderwood & Harkness LLP One Liberty Plaza, 45th Floor New York, NY 10006
Enclosures and Reference Documents
The following documents are referenced in this letter and are either enclosed herewith or will be delivered separately as indicated: