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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.
When thinking of the dental practice and its value to the owner, one of the most important aspects of the worth of the practice is the amount assigned to an intangible asset-goodwill. Besides the emphasis placed on goodwill and its appraisal as an item of significance, the differentiation between personal goodwill and the enterprise (dental practice) goodwill is an extremely critical point to consider. To define the amount of relevance allocated to each can be the difference between thousands of dollars to the owner when a transition occurs. This can be an associate acquisition or the outright sale to a hypothetical buyer after the practice is listed for sale and when the transaction eventually occurs. When planning the type of format for which the dental practice is organized, the entity decided upon has significance in terms of tax treatment that must be addressed. The allocation of the sale price in terms of asset importance regarding equipment, supplies, inventory, and other items on the settlement sheet is what the advisors to the dentist will strive for in the hope of encouraging the capital gain tax treatment for the seller of the dental practice. Personal goodwill should be the lead in the thought process.
Goodwill and the entity format of the dental practice
Besides all of the other considerations that a dental practice financial advisor or dental CPA may offer, the type of entity format is really one of the most critical. Here are some reasons and the type of business organization that affects the allocation of goodwill and what that assignment of the intangible means:
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Other types of business entities used to organize a dental practice
There are other types of business entities organized for dental practices such as hybrids of the above common dental practice formats and others. Whichever sort of business concept is used, it is important that an experienced advisor to dentists is retained to assist in the decision process. There is much at stake upon the eventual sale. This may occur years from the origination of the practice, so the allocation of personal goodwill may be overlooked when the time comes for the sale. A quick example in terms of dollars reflects what a mistake can mean to the owner who has worked his or her entire life and is now ready to retire comfortably after transitioning the dental practice.
An example of the dental practice transition using a hypothetical sale price
Using a hypothetical sale price of $500,000 and ignoring state taxes which are similar no matter what type of business entity is used, the federal tax on the allocation of personal goodwill would be approximately 20 percent of the sale price, or $100,000. If the sale price is $500,000 and there is no personal goodwill, the allocation is probably ordinary income. The owner would most likely have the following tax scenario: There would be double social security and Medicare on a portion of the sale price at $137,700 x 15.3 percent, or $21,068 in 2020. The portion of the Medicare tax of 1.45 percent x 2, as the owner, is unlimited so that after the $137,700 social security maximum taxable amount, the difference between that and the hypothetical $500,000, or $362,300 is taxed at the rate of 2.90 percent. That amount is ($362,300 x 2.9 percent) $10,507. There is one more self-employment tax based on the amount earned in excess of $250,000, assuming the taxpayer is filing a joint tax return. In this hypothetical case, the amount is an additional $112,300 x .9 percent or $1011. This all happens if there is no personal goodwill taxed at capital gains tax rates but at ordinary income rates. Besides federal income tax at approximately 35 percent, the owner upon the transition, owes an additional $21,068 plus $10,507 plus $1,011 ($32,586) and will be taxed on the gain at ordinary income tax rates and not at 20 percent, the capital gains rate. That taxable rate will be approximately 35 percent on the $500,000, or $175,000.
Analyzing the difference between a transition with personal goodwill and where there is no personal goodwill
Now one can see that the capital gains tax where the allocation of personal goodwill is available, results in a tax of approximately $100,000, or 20 percent of the $500,000. When there is no personal goodwill and based on the type of entity format, the tax can be as high as $32,586 for self-employment and Medicare taxes plus an additional 35 percent x $500,000, or $175,000 in ordinary income tax. The tax without an allocation for personal goodwill is $207,586. It pays to consult with a dental CPA or financial advisor prior to deciding upon which business entity to use.