By Blake Hassan, JD, CPA, and John McGill, JD, CPA, MBA
For years, buy-ins to dental practices have been structured such that the buyer acquires capital stock in the seller’s corporation at a price reflective of the net value of tangible assets inside the corporation. The intangible value is paid for via an income differential between the doctors over time. This approach effectively requires seller financing for the intangible value, and the amount paid for intangible value is taxed to the seller as ordinary income, although adjustment to the price may be made to offset the effect thereof. Gain on the sale of stock is taxable as capital gain to the seller. The buyer pays for the stock with after-tax dollars, but pays for the intangible value with pre-tax dollars.
We have seen a progressive increase in dental practice buy-ins structured as asset sales, under which the buyer does not buy capital stock but instead acquires a direct undivided interest in the assets of the practice (e.g., supplies, equipment, patient files, goodwill value, etc.). Generally, the seller pays ordinary income tax on the interest in tangible assets sold, while the goodwill is taxed as capital gain. The write-off period for the buyer varies depending on the asset classes acquired.
Under an asset sale structure, here are some characteristics and issues to be aware of:
1. Bank financing is likely available, which allows the seller to be paid in full up front. However, the bank will require some participation by the seller in securing the buyer’s loan, which may include a personal guarantee by the seller, the seller allowing a lien on his/her interest in the practice assets, or the practice entity guaranteeing the buyer’s loan.
Where the practice has existing debt secured by liens on practice assets, the bank holding such debt must consent to the sale. Depending on the bank’s requirements, the buyer may not be able to get bank financing.
2. Under recapture provisions in the Internal Revenue Code, gains from the sale of the tangible assets are taxable in the year of the sale, even if the seller finances the sale and takes payments over time. Accordingly, where a deal closes at or near year-end with no down payment, the seller is required to pay the recapture tax in the year of sale even though the seller did not receive any cash. Gain on the sale of intangibles will be taxed as payments are received, although the seller may elect to be taxed in the year of sale.
3. Once the buyer acquires an undivided interest in the practice assets, the buyer and seller may create a new entity under which they will practice. The type of entity will depend on state law and the desired tax environment. Generally, the entity will be taxed as a partnership, and may be a limited liability company (LLC). However, some states will not allow corporate members in a professional LLC, which will eliminate the LLC as a choice, and a general partnership will be used instead.
4. The new entity will have a new taxpayer identification number, and therefore a new provider number, and will need to be credentialed with third-party payers, such as insurance carriers and Medicaid. The credentialing process is time consuming and should be done in advance of the effective date of the buy-in to avoid delays in billings and payment.
5. The practice staff will be employed by the new entity, which will also become the sponsor for employee retirement plans, health insurance plans, etc. The new entity will have its own payroll and will file its own tax returns.
6. Accounts receivable are not typically included in asset sales, and therefore the new entity will need working capital, which may come from doctor contributions, a seller loan, or a third-party loan.
7. As an alternative to a new entity as described above, the doctors may choose to operate as separate practices, referred to as a group solo arrangement.
When considering a practice buy-in, the stock sale and asset sale methods should be compared, as the economic results to each party can be significantly different under the two. There are also practical differences, resulting from the fact that the asset sale leads to the creation of more than one entity.
Blake Hassan provides practice buy-in/buy-out and other legal services through McGill and Hassan, P.A, Attorneys at Law, an affiliate of the McGill & Hill Group, LLC, a one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment management services.
John McGill provides tax and business planning exclusively for the dental profession and publishes The McGill Advisory newsletter through John K. McGill & Company, Inc., a member of the McGill & Hill Group, LLC. For more information, visit www.mcgillhillgroup.com or call 877-306-9780.
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