Tax Implications on the Sale or Purchase of a Dental Practice
One of the least thought about but most often negotiated issues in selling a dental practice is the allocation of the purchase price and the associated tax consequences. A “satisfactory” offer prior to receiving and reviewing the proposed tax allocation could quickly become “unsatisfactory” thereby forcing the parties to renegotiate resulting in animosity, ill will, and in some cases, the transaction to fall apart. It is important to understand the tax implications of a sale prior to making and/or accepting an offer. We have provided below some of the most frequently asked questions along with a brief answer to each. For a better understanding, it is important to seek the advice of an experienced advisor prior to entering the negotiation stage.
Question: I am thinking of selling my practice, will I owe any taxes upon the sale?
Answer: In short, most likely yes. Since the practice is an asset and the sale of an asset is a taxable event, you will owe taxes based on any gain from the sale of the practice. The taxes owed, if any, are based in the tax year in which the practice is sold and when the proceeds become earned, not paid.
Question: Is the amount of taxes a seller must pay upon the sale of one’s practice a fixed percentage based upon the sales price or might the taxes owed vary?
Answer: The amount of taxes a seller will pay to the IRS will vary according to the “allocation” of the purchase price
Question: What do you mean by “allocation” of the purchase price?
Answer: It is probably easiest to explain this with an example. Assume Dr. Seller has been offered $500,000 for his practice. The $500,000 sales price will be broken down into different categories that are taxed at different rates by the IRS. For example, the allocation may be something like:
Supplies $ 15,000
Equipment/Furniture $ 75,000
Covenant not to compete $ 10,000
Personal Goodwill $400,000
Question: What difference does it make to me concerning how the purchase price is allocated?
Answer: Although purchase price is important, it should be only part of a selling doctor’s consideration of accepting an offer. The seller should also be concerned with how the purchase price is to be allocated for taxation purposes. For example, depending upon the tax entity you practice under, an allocation of the purchase price that allocates most of the sales price to the tangible practice assets that have been fully depreciated by the seller prior to the sale (i.e. equipment) will result in very dis-favorable tax consequences to the seller, as most of the sale price will be taxed at the ordinary income tax rate of the seller and not at the lower capital gains rate. In comparison, an allocation of the purchase price that allocates most of the sales price to the intangible practice assets (i.e. goodwill or patient lists) will result in very favorable tax consequences to the seller.
Question: Does it make a difference to a buyer how the purchase price is allocated?
Answer: Yes, the allocation of the purchased price does impact the buyer regarding how quickly the buyer will be able to amortize or depreciate the amounts allocated to the assets under different tax categories.
Question: Can the seller and buyer allocate the purchase price differently to gain preferable tax treatment?
Answer: According to the interpretation of IRS code by the majority of accountants we have dealt with, each party will be required to file with their tax return an IRS Form 8594 which breaks the purchase price into IRS defined Categories. These Forms need to match or you will risk an IRS audit of the transaction.
Question: As a seller, does it make a difference to me, from a tax liability perspective, what type of entity (Sole proprietor, S Corp., C Corp or LLC) I am operating my practice under?
Answer: Yes, based on the type of entity you operate under, the tax implications vary; therefore the analysis in structuring the allocation may be different depending upon your selected entity.
In closing, the above FAQ’s are stated to help you better understand the tax issues that arise from the purchase or sale of a practice. The authors do not intend this article to provide tax advice and strongly advise you to always seek the advice of a qualified accountant or tax attorney.