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Bruce Bryen is a certified public accountant with over 45 years of experience and is a part of Baratz & Associates CPAs. He specializes in deferred compensation, such as retirement planning design; income and estate tax planning; determination of the proper organizational business structure; asset protection and structuring loan packages for presentation to financial institutions. He is experienced in providing litigation support services to dentists with Valuation and Expert Witness testimony in matrimonial and partnership dispute cases. He is also a financial writer for several dental journals. You may contact him at 609-502-0691 or at Bryenb@baratzcpa.com, or through www.Bryen-BryenLLP.com.
What dental practices need to know about the financial impact of the allocation of goodwill whether a transition to a third unknown party, an acquisition of a partnership interest, or divorce proceedings.
For a dentist who is involved in a transition, divorce or potential ownership position, the accounting for goodwill is of the utmost importance. It has a tremendous bearing on the reputation of the dental practice. It is also a valuable asset when it comes to determining the tax ramifications of a transition to a potential buyer and to the seller, whether that may be a partnership situation or an outright sale.
During divorce proceedings, the segregation of personal goodwill from the dental practice goodwill or enterprise goodwill value could mean hundreds of thousands of dollars. In equitable distribution states where personal goodwill is not part of the marital estate, the allocation of personal goodwill rather than enterprise goodwill separates what is to be distributed from the practice compared to what is not to be distributed. We will look at each of these points and describe with examples how each is treated in the following paragraphs.
The sale of the dental practice to a third party
In the event that the owner or owners of the dental practice have decided to sell it and have found a buyer, the advisors to the dentist(s) will offer advice about how to allocate the proceeds of the sale. This is an extremely important point in the discussions because the goodwill of the dental practice is treated in such a way that the sellers receive a capital gains tax treatment. If the dental practice is a C corporation, then it is even more important that the allocation of the goodwill between the dental practice (enterprise) and the personal goodwill of the dentist have excellent support for the basis of the allocation.
The capital gains tax treatment will be the lowest tax paid upon a transfer for a complete transition of the ownership where the funds go directly to the seller or sellers. There will probably still be a state tax but that would occur anyway without a sale of the practice. If the organizational format of the dental practice is not a C corporation it is still important to allocate the personal goodwill and the dental practice goodwill especially if there are two or more owners. Each of the selling dentists may have a different perspective as to how much goodwill should be allocated to each and how much should be apportioned to the dental practice. With a partnership arrangement as an example, there may be a profit sharing arrangement that is different than the ownership arrangement. Many factors such as production capacity of each partner may be taken into account when determining who receives what allocation upon the transition. It is also important to know that with the allocation of the transition proceeds to goodwill for the seller, the buyer receives the lesser ability to write off the amount allocated to the goodwill. This is a common occurrence in a transition in that whatever economic and tax benefit that goes to one party in the transaction, the other party has a reduced benefit in comparison. A potential acquisition of a partnership interest is treated the same way as the sale to a third party except for the potential discount for past services or for some formula based on production.
Goodwill represented in a divorce involving a dentist
The goodwill allocation in a divorce that is segregated between the personal asset and the goodwill of the dental practice is probably the most important proration of goodwill other than the income tax result of the value placed on goodwill. An example in a state where there is equitable distribution allows the personal goodwill of the dentist to be separated from the marital asset value so that only the goodwill of the dental practice is available for distribution to the spouse of the dentist.
It is critical for the evaluation of the dental practice to be clear with plenty of support for the presentation to a mediator or to a court so that the personal goodwill can be substantiated. This amount attributed to the personal goodwill is the dentist’s and can not be transferred. It is not available for the spouse as the dental practice goodwill is. Examples of the dental practice goodwill would be the dental equipment, furniture, and any item of personal property.
Some dentists do have leasing companies whereby those assets are in their own name and rented to the dental practice so that they would not count as marital assets since the lease would provide a debt to the dental practice and reduce those asset values. If it is proven that patients are coming to the practice not because of the dentist but that that practice is easily accessible and the patient would see any dentist, then that is not considered to be personal goodwill. This is but an example of how difficult it is to prove what may be personal goodwill versus dental practice goodwill. Only an experienced dental practice evaluator can present a valuation of the dental practice that is supported by other articles, books and previous experience.
Whether a transition to a third unknown party, an acquisition of a partnership interest or divorce proceedings, the allocation of goodwill is a huge financial point. If the goodwill allocation is primarily towards personal rather than dental practice goodwill, the seller of the practice receives a huge tax advantage. In a divorce, the personal goodwill allocation to the dentist allows him or her to retain probably the most valuable asset in the dental practice. Start with a dental practice valuation by a CVA for an independent opinion that will be supported and will be looked upon favorably by a mediator or a court.