Optimize Tax Efficiency and Safeguard Financial Goals with MSOs for Closely-Held Companies

Management Service Organizations (“MSOs”) present a compelling opportunity for business owners to leverage the disparity between corporate and personal tax rates—allowing them to more efficiently grow their businesses, increase retirement income, and transfer wealth to future generations.

The Challenge for Closely-Held Companies

Many closely-held businesses operate as pass-through entities (S-Corporations, Limited Liability Companies, or Partnerships). In these structures, company income is taxed directly to the owners—often at individual rates as high as 37%.

Transitioning to a C-Corporation, with its lower 21% tax rate, can be appealing. However, business owners are often hesitant due to concerns about double taxation when extracting funds.

MSOs offer a unique way to capture the benefits of the C-Corporation tax rate while avoiding many of these drawbacks.

How an MSO Works

A business owner with an existing pass-through entity (the “Operating Company”) can establish a Management Service Organization (MSO) that is taxed as a C-Corporation.

The MSO provides various services to the Operating Company—such as managing compensation for the owner and employees, and covering shared operational expenses.

In return, the Operating Company pays the MSO a service fee, reducing the income that would otherwise be taxed at high individual rates. The MSO, in turn, recognizes that income at the lower corporate tax rate and typically retains earnings within the entity, mitigating concerns about double taxation.

Those retained funds can then be used to:

• Reinvest in the business
• Establish or enhance retirement plans
• Engage in life insurance strategies for key person coverage, business succession, and wealth preservation

Combining MSOs with Split-Dollar Arrangements

One potential strategy involves using a portion of the MSO’s retained earnings to fund a Split-Dollar Life Insurance Arrangement.

The MSO can loan funds to an Irrevocable Life Insurance Trust (ILIT), which then purchases a life insurance policy on the business owner’s life.* Interest and principal on the loan can be repaid using the policy’s cash value or death benefit, while the owner’s heirs receive the net proceeds free of income, gift, and estate taxes.

To further enhance the efficiency of this strategy, Schechter can help the MSO finance the policy premiums—allowing business owners to fund a larger policy using the same MSO dollars by paying interest rather than premiums.

The Result: Efficiency, Flexibility, and Legacy

By strategically designing and implementing an MSO—and integrating it into a comprehensive business, retirement, and estate plan—business owners can:

• Optimize tax efficiency
• Enhance retirement cash flow
• Preserve and transfer wealth for future generations

MSOs are not one-size-fits-all. When thoughtfully structured with expert guidance, they can become a cornerstone of a more tax-efficient, growth-oriented financial strategy.

*Consult your legal, tax, and financial advisors before implementing any MSO or Split-Dollar arrangement.