By Roger K. Hill, ASA, and John K. McGill, JD, CPA
The real event
A new doctor recently acquired a 50% interest in the practice where he was employed. A few years later, he purchased the remaining 50%. As it happens, the entire purchase price was allocated to stock in the selling doctor’s corporation. While this was beneficial to the seller in that all of the gain was taxed at capital gains rates, the effect on the new doctor was not nearly as helpful.
The new doctor paid not only the entire value of the practice with after-tax income, but the interest as well. In addition, stock cannot be depreciated; thus it was very difficult for the new doctor and now 100% owner.
The central question was simple — could this be rectified? Thankfully, the answer was yes. Soon after the seller retired, the new owner doctor brought an associate into the practice. After some time, the associate expressed a desire to purchase a fractional interest.
Step 1 in the solution was to sell 50% of the stock to the associate for an amount less than the owner paid for it. (The value assigned to the stock was essentially equal to 50% of the value of tangible items, not including intangible value. Thus, he was selling the stock for far less than he paid, creating a capital loss.)
Step 2 was to sell all the intangibles (personal goodwill and related items) from the new owner (individually) to the associate as a sale of intangible assets. The sale of these assets (essentially equal to the value of the fractional interest, less the amount allocated to the stock) created a capital gain to the owner doctor.
However, the capital loss incurred in step 1 offset the gain from the sale of the intangible assets in step 2. Without a capital gain such as the one created by this structure, it would have taken the owner doctor multiple lifetimes to write off the capital loss at the specified rate of $3,000 per year.
Two powerful tax strategies when selling your practice
1. The choice of the form of entity by which you practice will affect the tax liability when you sell either the entire practice or a fractional interest. In general, practicing as a sole proprietor (i.e., unincorporated) may be the best choice at the time of sale, but for purposes of minimizing taxes in the meantime, and protection from general liability, it may not be the ideal choice.
A step up from this is an LLC (limited liability company). Many states allow a single-member LLC, which provides protection from general liability without becoming incorporated. As a general statement, an LLC is a blend between a sole proprietorship and a corporation.
Or, consider operating as a corporation. A subchapter S corporation provides both tax efficiency and general liability protection. It also provides for tax-saving efficiencies at the time of the sale of all, or part, of your practice.
2. When selling a practice (or partnership interest), a portion of the purchase price will be allocated to the fixed assets. Because these assets have typically been fully depreciated, the gain (that is, the amount of the purchase price allocated to the fixed assets, less any remaining balance) will be taxed at ordinary rates.
Thus, the timing of the sale becomes an important consideration. If you plan to retire completely, or only work part-time post-sale, your individual tax bracket may be lower in the year(s) after the sale. Thus, to the extent that the sale occurs in the year when you will be in a lower tax bracket (that is, post-sale), you will pay less tax.
For example, suppose $100,000 is allocated to fixed assets. If you sell late in a calendar year, your earnings from January until the sale date may already put you at the highest income tax bracket, currently 35%.
However, if the sale occurs in January and your earnings are less in the year(s) post-sale, you will likely be in a lower tax bracket. For example, assume that your post-sale earnings are now taxed at 28%. The tax savings will be approximately $7,000 (using the aforementioned $100,000 allocated to fixed assets, as an example). If you are in the 15% tax bracket, your savings will be approximately $20,000.
Roger Hill provides transition planning for practice sales, partnerships (buy-in/buy-out), practice mergers, associateships/compensation analysis, and financial forecasting (proforma) through Roger K. Hill & Company, a member of the McGill & Hill Group, LLC. 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.
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