Taxes. Ugh. The word alone is enough to leave a taste worse than alginate in your mouth. And most would agree that paying taxes is worse than a molar root canal, either giving or receiving.
So how does one write an article about tax and make it interesting? By exploring ways to avoid them or make them lower. At least that is the only part of taxes we find appealing. We assume you agree, otherwise you would stop reading this article right now.
Since you are still reading, we are glad you agree. So, short of running for Congress and single-handedly reforming tax law (which, given the state of Congress, is less likely than growing a third set of teeth), what can you do to lessen the tax liability you incur from selling your dental practice? You have worked hard your entire career to earn a decent living and build something of value. It only makes sense that you should be allowed to retain as much of that value as possible and turn the least amount possible over to government to “use” as it sees fit.
So let’s explore some tax mitigation strategies associated with a dental practice sale.
Stock Sale. If you are incorporated, a sale of the stock in your corporation to the buyer of your dental practice will potentially yield you the greatest tax savings because the sale of stock is almost exclusively taxed at the lower fixed capital gains rate as compared to the higher, tiered ordinary income rates. However, and this is a BIG however, stock is a non-depreciable asset to the buyer. As such, the buyer is not able to write off the sales price and essentially ends up buying your dental practice with after-tax dollars. Consequently, a buyer is likely only to agree to buy your stock if you are willing to reduce your purchase price substantially. For this reason (and all of the associated legal and liability complications), almost all dental and dental specialty practices are sold as “asset sales.” In other words, the seller retains his/her corporation and all of its stock and instead sells all of the tangible and intangible assets of the corporation (i.e., the practice) to a buyer since a buyer is then able to depreciate and amortize (write off) the entire purchase price overtime.
Price Allocation. The IRS requires the total price of a practice be allocated to the various types of assets being sold and that the allocation be made according to the fair market value of the assets. As a general rule, the tangible assets are taxed as ordinary income above basis, and the intangible assets are taxed as capital gains. (Above basis means the difference between what you are selling the tangible assets for and your book value or depreciated value). Any consideration for a covenant not to compete will also be taxed as ordinary income. Since “fair market value” is somewhat subjective, there is some room for negotiating the overall allocation of the purchase price. As a seller, it will benefit you (and by that, we mean you will save taxes) if you can negotiate with a buyer for a lower allocation to tangible assets (viz.,equipment, furniture, fixtures, supplies, etc.) and a higher allocation to intangible assets (viz.,goodwill and patient records). However, it will benefit the buyer to have just the opposite allocation, so consideration must be given to making the allocation fair to both parties.
The IRS requires that the purchase/selling price of a practice be separated into various components, such as furniture, equipment, goodwill, covenant not to compete, patient records, consulting, supplies. The buyer and seller must agree on the allocation and attach a form with their income tax return reporting the allocation. There are significant tax savings and tax consequences to each party in connection with the allocation. It is time well spent to understand the tax consequences with your accountant on each component and obtain the best allocation possible by each party.
Seller carrying back a note. Since most of the remainder of the sales price will be taxed as capital gains and since the capital gain tax rate is a fixed rate, irrespective of ordinary income or ordinary income tax rates, the same tax will be applied and the same tax amount owed whether you receive that portion of the price now or paid to you over time; unless there is a change in the capital gains tax rate before the note you are carrying is paid off. Otherwise, self-financing a portion of the price serves only to defer capital gains tax, but it will not lower the total tax. Therefore, we usually do not see many sellers carrying back a promissory note on selling their dental practice.
Sale Timing. As discussed above, the tax associated with recapture over basis on the sale of tangible assets will be determined by your ordinary income tax bracket in the year of the sale. If you are planning to retire after the sale of your dental practice and, consequently, will have a drop in your ordinary income level, it may behoove you to strategically time the sale of your practice until after the start of the next tax year.
“C” Corporation Consideration. If you are currently incorporated and being taxed as a regular “C” Corporation, the sale of goodwill by your corporation will likely be subject to double taxation once as capital gains inside your corporation and then again as ordinary income when paid as a distribution to the shareholder(s). There is some case precedence that allows for the shareholder(s) of “C” Corporations in closely held and professional businesses to sell goodwill individually, outside of the corporation, thus avoiding that double taxation. If this applies to you, consult with your accountant and/or tax attorney regarding the details of such a tax strategy and its application to your particular situation.
1031 Exchanges. If you are selling a dental practice now and plan on buying another dental practice within 45 days, a 1031 or “Like Kind” Exchange may be a tax deferral strategy to consider. It allows you to defer the taxes associated with recapture over basis you would otherwise incur with the sale of your tangible assets. A 1031 Exchange has very specific and rigid requirements to accomplish correctly. The specific details and mechanics of this tax strategy are beyond the scope of this article. As such, consult with your CPA and/or tax attorney regarding the details of such a tax strategy and its execution.