Management Services Organizations (MSOs): How Employers Can Safely Manage the Risk of a Hidden Workforce

Management Services Organizations (MSOs) are increasingly used by professional and service‑type businesses to separate the administrative operations of a business from its core professional services. The model is attractive because it can bring operational expertise, unlock access to capital, and support business growth without changing who has controlling decision‑making authority. But while MSOs can solve ownership, governance, or regulatory challenges, they can also introduce less visible risks in other areas, such as employee workforce, benefits plans, and tax compliance. These are risks that won’t show up on a balance sheet. Instead they surface later on, possibly after the organization has scaled, its benefits plans have matured or, even worse, once a transaction is already underway.

What Is an MSO?

Under an MSO model, one entity delivers the client‑facing services, while a separate entity handles business operations, such as, human resources and payroll, finance and billing, technology and data systems, marketing and branding and facilities and administrative support. The operating entity typically pays the MSO a fixed fee for these services, rather than sharing the business revenue.

This structure is common in healthcare and other professional services industries. The business logic is simple, investors and operators manage administrative responsibilities while licensed or credentialed professionals control and perform the business services.

MSOs Tend to Become Deeply Integrated with their Related Operating Entity

Even though the MSO and the professional entity are legally separate from one another, in practice, MSOs rarely operate at arms’ length from the professional entity. It is not uncommon for an MSO to become functionally merged with the operating entity for which the MSO provides management services. Often, this combination emerges from a desire to maximize the efficiency of the MSO. For example, in order to deliver efficiency and scale, MSO arrangements often evolve to include long‑term or exclusive service agreements, shared branding and market presence, centralized hiring, compensation and benefits and overlapping leadership and governance. This integration is intentional and necessary from a business perspective. However, from a compliance perspective it blurs the line between two separate entities and a single enterprise.

When Separate Companies Become Treated as a Single Employer

Under the Internal Revenue Code (the “Code”), ‘separate companies’ might not mean ‘separate employers.’ The Code includes a section of rules intended to look past corporate entity structures and legal separateness to assess whether ostensibly separate entities are functionally operating as a single enterprise. The Code refers to such related entities as controlled groups or affiliated service groups. In simple terms, these rules assess whether the organizations are sufficiently interrelated through shared ownership, management or services, that they must be treated as a single employer for employee benefits purposes.

If the answer is yes, employees across all entities must be treated as a single workforce employed by a single employer for several employee benefit related purposes, including, retirement plan nondiscrimination testing, Affordable Care Act compliance and other group health plan obligations and tax reporting and compliance. An employer’s intent or purpose has relatively minimal significance in determining whether the entities are in a controlled group or affiliated service group. This status is almost entirely dependent on the facts and circumstances. Even if an organizational structure were designed for certain regulatory or governance reasons, the entities can still be treated as a single employer under the tax code.

Why MSOs Are Especially Exposed to Controlled Group and Affiliated Service Group Status

MSOs are particularly susceptible to these aggregation rules because they often involve one organization performing routine management services for another, economic dependence through exclusive or long‑term contracts, shared control over employees, compensation and operations, and often times common ownership between the entities. Each of these factors combined significantly increases aggregation risk.

Furthermore, because these aggregation rules are extremely technical and complex, organizations often don’t realize they have a problem until a benefits plan fails its annual testing, a regulatory review uncovers historical (and sometimes, perennial) noncompliance, or a transaction or financing round gets delayed. At that point, the fixes become more difficult and significantly more expensive. In certain scenarios, the plan’s qualified status can be put at risk, causing potentially catastrophic consequences to the participants and the employer, as plan sponsor.

Lessons from Industries That Use MSOs

Many medical practices that used MSOs have eventually discovered that employees across the practice and the MSO needed to be treated as one group for retirement or welfare plan purposes. In some cases, this problem cascaded into unexpected benefit liabilities, corrections spanning multiple prior years (with penalties and interest charges) and required plan redesign. These outcomes weren’t the result of neglect, or aggressive or malicious planning. They were simply the result of desired growth and evolving operational integration over time.

A Structural Tension Employers Should Understand

MSO structures are often utilized to comply with industry‑specific ownership rules. But success in one area does not guarantee success elsewhere. Some of the features that make an MSO model commercially effective (i.e. exclusivity, centralized control and integration) are the same features that increase the risk of aggregation under the controlled group or affiliated service group rules. This structural tension is the result of the two distinct goals of the tax and regulatory regimes. Regulatory, ownership and governance rules focus on professional independence and control. Tax and qualified plan rules focus on practical operations and employee protection. These are both always operating in different lanes at the same time.

What This Means for Employers and Benefit Plans Committees

MSOs can be powerful tools for company growth, succession planning, and operational improvement. But they need to be evaluated from an overall enterprise perspective and not only as a means to avoid a legal or regulatory burden. A company considering or currently operating under an MSO model should evaluate the overall impact before implementing the MSO structure (or as soon as possible afterward). Employers should understand that a delay in addressing these issues now can allow problems to grow silently over time as the company achieves its markers for success due to the same factors (e.g. company growth and operational efficiency) that trigger controlled group and affiliated service group problems. Proper planning can also materially reduce the costs to resolve unintended compliance failures. It is also important for employers to realize that the controlled group and affiliated service group rules cannot be contracted around. Addressing all of these issues proactively allows a company to capture the benefits of the MSO model without turning a strategic solution into a long‑term headache.

This communication is not intended to create or constitute, nor does it create or constitute, an attorney-client or any other legal relationship. No statement in this communication constitutes legal advice nor should any communication herein be construed, relied upon, or interpreted as legal advice. This communication is for general information purposes only regarding recent legal developments of interest, and is not a substitute for legal counsel on any subject matter. No reader should act or refrain from acting on the basis of any information included herein without seeking appropriate legal advice on the particular facts and circumstances affecting that reader. For more information, visit www.buchalter.com.