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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.
Educating buyers and sellers about the benefits of this approach is key.
With closely held dental practices and composites of owner(s) and employees meeting certain criteria, implementing an employer-sponsored qualified retirement plan may be an ideal methodology for acquiring a dental practice. Of course, there are variables to consider. Identification of some of these and reasons why this idea is in the interest of dentists will become clear in this article.
Why this approach is important to buyers and sellers of dental practices
The importance is defined with just one word: taxes. A mix of employees maintaining proper job classifications, ages and number of years worked can save or defer hundreds of thousands of dollars. An example follows: In a typical sale, sellers hope to receive capital gains treatment by allocating a membership interest, stock, goodwill, or some other capital asset in the sales agreement. Buyers hope to write-off as much as possible and as quickly as allowable. With the seller’s acceptance of capital gains tax treatment, the buyer will almost always have a best case write off over 15 years. Educating buyers and sellers about the positives of using the employer-sponsored qualified retirement plan for transitions will make them aware of the incredible benefits available.
Examples of its positives and negatives
The key word is “taxes.” Suppose the dental practice transition is set at $1 million. If the seller has a conventional sale and 100 percent is reported as a capital gain, then the federal and state taxes would be approximately 30 percent or more. If we use 30 percent for our calculation, then 70 percent would remain after the subtraction of the $300,000 tax, or $700,000 available for investment. The buyer is writing off the $1 million at the rate of $66,667 per year for 15 years if the acquisition price was allocated to goodwill. This is not a quick deduction for the buyer assuming he or she understands the present value of money and has just borrowed $1 million to acquire the practice. It leaves the seller with $700,000 of the $1 million for investment. At 4 percent per annum, that rewards the seller with $28,000 per year, if the investment is non-taxable.
How does the implementation of the qualified employer-sponsored retirement plan change the above outcome?
With the prior example, the seller retains $700,000 by reporting the transition and paying capital gains and state tax. The following is an example of the use of the qualified employer-sponsored retirement plan and its effect:
With the deferral into the qualified employer sponsored retirement plan, there should be little or no tax. In this instance, the seller is starting with $1 million instead of $700,000. The same 4 percent return is used for comparison. The 4 percent equates to $40,000 and not $28,000 since the amounts multiplied by the 4 percent return are in one case, $700,000 after tax and with the retirement plan, $1 million.
A two-year comparison follows:
With the use of the retirement plan, the seller has $1 million at transition in his or her deferred compensation account and at the end of year one, $1,040,000 ($1 million x 4 percent). At the end of year two, the seller has $1,081,600 ($1,040,000 x 4 percent).
In comparison, the capital gain approach rewards the seller with $700,000 at closing and at the end of one year the amount grows to $728,000 ($700,000 x 4 percent) before tax. At the end of year two, the seller who used the capital gains concept will have $757,120 ($728,000 x 4 percent) before tax. In this example, the assumption is that the 4 percent is in a non-taxable investment so that the comparison using the retirement plan is “apples to apples.” Of course, taxes must be paid when the seller withdraws funds from the retirement plan> If one looks at the comparison of the two ideas, when the taxes are paid by the seller who uses the retirement plan, those taxes will come from funds that he or she never would have had since the qualified employer retirement plan accumulates its growth without tax until withdrawal.
Dental CPAs and the innovative approach
The above approach to tax and the use of the present value of money is something to discuss with the practice owners’ dental CPAs prior to the transition. It takes each party to the transition to understand the value of what will be retained when the qualified employer-sponsored retirement plan is utilized with this important transitional moment in each dentist’s life.