The regulatory environment is quickly changing and those changes are affecting how certain physician deals must be structured. If you plan to employ a physician and house them in an existing private practice, these guidelines are important. The advantage for the employed physician is access to office space, staff, supplies, etc. without the cost of establishing an office de novo. Consequently, the private practice will benefit by spreading overhead expense over an additional physician and increasing their contribution margin.

The value paid for overhead and staff must not be based on the volume of patient referrals. One of the acceptable methods for purchasing overhead from an existing physician group or solo practitioner is by developing a time block lease.

The time based lease represents a specific payment, set in advance, for exclusive use of designated areas, staff and equipment during office hours. This amount is derived from the practice’s existing profit and loss statement. However, certain adjustments must be made in developing the lease rate for space and overhead services. Here is a list of the primary areas that should be addressed in this analysis:

Rental of office space

The lease rate for the office space must be commercially reasonable and the aggregate rental charge needs to be consistent with fair market value of the property for general commercial purposes.

After the proper lease rate is determined, the office must be broken down by square feet per area. Office space that will be used exclusively by the “lessee” physician needs to be segmented from the rest of the office space. Office space not used by the “lessee” physician should be excluded.

When the physician (or the hospital in lieu of the physician) is paying for certain exam rooms during his/her scheduled office time, that physician is the only practitioner allowed to use the designated area during the designated time span. Violation of this rule is viewed as payment for referrals. This time should be broken down into daily increments and half-day blocks. The common office space used by everyone must be allocated using a method that does not consider referrals.

Rental of equipment

The value of the equipment should be fair market value. This amount can be determined from the list of hard assets, but the accumulated depreciation and salvage value must be adjusted for reasonableness. If the equipment is leased, the lease rate can also be based on fair market value, or replacement cost. In both cases, it may be appropriate to include a market-based interest expense consistent with a lease rate for equipment obtained through a manufacturer. Separate lease arrangements are recommended for Designated Health Services.

“Per click” or volume-based payments are no longer allowed under the most recent Stark update. The primary concern of CMS and the OIG is that the “lessor” physicians are going to receive additional value one party would attribute to the proximity or convenience to sources of referrals.

Staff expense

The compensation paid for any staff that serves the patients to be seen by the “lessee” physician should be included in the calculation. This includes benefits and other direct staff expenses. If a particular member of the staff will have absolutely no interaction with the “lessee” physician’s practice and patients, they should be excluded from the lease calculation. An employee with multiple job duties can be split based on approximate time. The direct expenses of a nurse practitioner that provides medical care in the practice separate from the “lessee” physician should be excluded from the lease rate calculation.

Overhead expense

General overhead expense from the practice can also be allocated to the “lessee” physician using the office space. This includes office supplies, medical equipment, utilities, and other general office expenses. Direct physician expenses for the “lessor” physicians are not allowed in the calculation of the lease rate. This means that malpractice costs, dues, licenses, entertainment, auto expense, benefits, etc. must all be removed from the expenses used to calculate the lease rate. Also, non-operating expenses, such as depreciation and interest expense, should be excluded.

We recommend that the hospital’s legal department be involved when structuring the lease rate. The attention to detail in the deal structure is very important when determining fair market value.


Neal D. Barker

Partner and Managing Director, Compensation and Compliance