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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.
How does one feel after successfully marketing the practice with a good practice broker and finally finding the buyer that is the right fit for the patients and staff? After working for years to increase the worth of the practice and building its reputation and image, everything seems in place to have the buyer’s representatives review the financial data and then bring the offer to the closing. The feeling is one of euphoria. Now the buyer’s advisors arrive to analyze the price of the practice and the cash flow available to repay the debt used for the purchase price. Based on the guidelines established to allow a capital gains treatment as the seller and its favorable tax treatment, the buyer’s representatives reveal a surprise to the acquiring dentist. Based on the unfavorable tax treatment attributed to the buyer, the unwelcomed surprise is that the tax due on the loan reduction is not available to the buyer from the dental practice’s cash flow. What that means to the buyer is that the loan repayment, using a conventional sales approach, will not allow the buyer to acquire the dental practice.
Let’s look at a hypothetical situation where the sale price of the dental practice is $500,000 and the terms of the sale allow the seller to receive capital gains treatment. A typical five-year loan will cause the annual loan reduction to be about $100,000 on average. If the seller is transferring goodwill to the buyer, it means that the buyer must amortize the $500,000 purchase price over 15 years. The write-off to the buyer for the goodwill allocation is $33,333 per year for 15 years, which equals the $500,000 purchase price. The loan reduction at $100,000 per year for the first five years when the coordination of the practice acquisition is probably at its most vulnerable, financially, causes $66,667 to be taxable to the buyer at ordinary income tax rates ($100,000 minus the write off of $33,333). The buyer then has a hypothetical tax due on $66,667 of income. Since the buyer/owner pays both halves of social security and Medicare at a little over 15% and a hypothetical federal income tax rate of almost 40%, those two equal a tax rate of 55%. Of course in a state like New York or New Jersey, the buyer also pays a high state tax rate in the range of 8% so the total tax rate is above 63%. This means that a buyer pays about $42,000 per year in tax for the first five years of the acquisition ($66,667 times 63%).
A sophisticated approach to the conventional, broker-friendly sales method just described, where more input is needed from dental CPAs is with the use of qualified employer-sponsored retirement plans for the amortization of the purchase price. The use of this type of scenario causes the largest part of the purchase price that would be subject to a huge tax rate to the buyer to be less onerous. It allows the cash flow in the early stages of the acquisition to be used for the acquisition and not for the tax payment. Here’s how: It is important to understand that the amortization of the loan is not deductible. The interest is. Similar to someone’s personal mortgage, when the interest payment is made it is deductible but the loan amortization is not. If the payment for the purchase price is allocated to an expense item, which an employer-sponsored qualified retirement plan is, then the purchase payment is deductible. The payment is part of the ordinary expense of the dental practice and the end result is that the funds are used for retirement when withdrawn and taxes are paid on the disbursement at that time. Of course, the tax payment comes from funds that would never had existed since under the conventional acquisition model, the taxes would have been paid over the first five years as previously detailed in this article.
To obtain advice on this type of approach to a dental practice acquisition with the resultant tax approach, a dental CPA who has extensive experience in assisting in the design of retirement plans is the choice of advisor needed to complete the transaction.