by Roy R. Rice, CPA
Before buying or selling a dental practice, great care and planning should be taken to consider the tax consequences regarding the allocation of the sale price to the various assets involved in the transaction. Typically, the group of assets that would be sold between the selling party and buying party would include dental supplies, furniture, fixtures, and equipment used in the practice, patient files, and goodwill of the existing practice. The objective of the seller is usually to allocate the sale price of the assets in a way to minimize the income tax owed on the gain. The objective of the buyer is to allocate the purchase price to accelerate the tax deduction on the assets he or she has purchased. These objectives typically conflict with each other, and therefore the tax costs or savings can have a significant bearing on the agreed-upon price.
The purchase/sale contract should specifically stipulate the allocation negotiated between the parties. It will generally be honored by the IRS as a fair representation of the market values of the assets. Your attorney and advisors need to factor the tax considerations involved in the allocations before the final transaction price is resolved.
The seller will pay income tax on the gain, which is the difference between the sale price and the tax basis in the property sold. Generally, it is an advantage to the seller to allocate the sale price to reflect more proceeds being allocated to assets that will generate long-term capital gains and less proceeds to assets that will generate ordinary income. The noncorporate federal tax rates for ordinary income range from 10 percent to 35 percent, depending on the seller’s level of income. The long-term capital gains rate is a flat 15 percent, regardless of the level of income (there is no difference in the corporate tax rates for ordinary income and capital gains).
Prior to the sale, dental supplies most likely have been expensed as they are purchased. Any gain associated with the sale of these dental supplies would be ordinary income. The furniture, fixtures, and equipment used in the practice would be depreciated by the seller and would have a net book value equal to the original cost less the prior depreciation claimed. The gain on the equipment is measured by the difference between the allocated sale price and its net book value, and is generally going to be categorized as ordinary income to the extent of prior depreciation deductions.
Finally, the goodwill of the practice is a capital asset and eligible for capital gain treatment. Based upon this discussion, it is an advantage to the seller to allocate more proceeds to the goodwill and less to dental supplies and equipment.
The buyer of the practice will record on his balance sheet the allocated purchase price of the assets acquired in the transaction. He will recover (deduct) the cost based upon the type of asset. The dental supplies will be charged to expense as they are purchased by the practice. The furniture, fixtures and equipment are subject to depreciation; the tax code specifies a period of five or seven years to write-off the cost. Additionally, under certain circumstances, all or part of the cost of the equipment may be expensed in the year of acquisition. The goodwill purchased in a practice is required to be amortized over a period of 15 years. Therefore, it is an advantage to the buyer to allocate more of the purchase price to the supplies and equipment and less to the goodwill.
Regardless of the desires of the buyer and seller, it is important that the allocations are supported as reasonable based upon the circumstances.
Another consideration involved in the sales transaction is the financing. The buyer may borrow all the funds from a bank or other lender, and pay the seller the full purchase price at closing. Alternatively, the seller may want to finance the asset acquisition for the buyer. Using this option, the seller generally pays his or her taxes over time as the cash payments are received from the buyer. Tax-wise, this option may benefit both the seller and buyer.
Finally, the type of entity used by the seller can have a significant bearing on his or her tax cost and should be taken into consideration prior to concluding the sale. If the selling doctor practices in a “C” (regular) corporation structure, additional planning must be considered to avoid possible double taxation on the corporation and doctor.
Roy R. Rice has practiced in Indiana as a CPA for 38 years. He consults with numerous dentists in the areas of practice transitions, taxes, and accounting. He lectures at Indiana University School of Dentistry and is the Indiana representative for American Dental Sales.