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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.
Tips on how to get the best tax relief when selling your dental practice.
As the dental practice attains growth in reputation, revenue and profitability, there comes a time when the owner feels the time is right for a practice transition. Whether because the work is becoming too demanding, the ability to find associates too difficult or for any other reason, he or she feels that the height of the dental practice value is close at hand.
The first step should be a practice valuation. This is important because even though the dentist has an excellent understanding of how to evaluate his or her own practice performance, an outside evaluator will do so without any bias that the owner may possibly have. Once the value is accepted by the owner, the steps to take place typically start with the dental CPA, an attorney who understands the dental world and the engagement of a practice broker.
The following is some good and bad news that will be received from the dental CPA regarding the transition.
The owner wants to receive the highest price and the best terms possible for all of his or her long hours and money invested in the practice over the years when the transition occurs. It is important for the seller to understand that in the transition process, the dental CPA will play a very important role in assisting the owner. He or she will explain that what remains after all of the costs of the settlement with the buyer is what really counts for probably one of the largest receipts of funds in the dentist’s life. This though, is really only one of the starting points in determining what remains because the biggest cost to the seller will probably be the total of the state and federal taxes that come from the proceeds of the transition. Another point is that when a transition occurs, a positive allocation of the purchase price for one party will result typically in a negative result for the other. An example would be a capital gain to the selling dentist. The attribute of goodwill for the seller which is treated as a capital gain, results in the buyer receiving one of the least favorable treatments regarding his or her own taxes. Capital gains typically have the lowest tax rate available so a seller would be happy. For the buyer, the acquisition of goodwill has a 15-year write off period. This is a very long term for a buyer especially if the transition loan is less than 15 years. Hypothetically, if a buyer is able to obtain a 10-year loan, it means that there are 10 years of loan payment and 15 years of tax write off. Since the principal portion of the loan payment is not deductible to the buyer, the use of the goodwill write off is a critical piece of tax planning.
An example using dollar amounts follows.
Using some hypothetical dollar amounts from the above description, a clearer understanding will jolt the buyer. If the net gain after payment of commissions, professional fees and other closing costs equals $500,000, the seller will hypothetically pay about 26% in federal and state taxes ($130,000), assuming that he or she lives where there is a state tax. That means that the seller will have 72% of the $500,000, or $360,000 for use in retirement, lifestyle expenditures or what ever else pleases the seller.
For the buyer, if the purchase price was $600,000 hypothetically, since the seller’s costs before tax included a 10% commission besides other settlement costs, and if the buyer borrows the $600,000 for 10 years, the buyer is paying about $60,000 per year in principal. If 100% of the purchase price is allocated to goodwill in this hypothetical example, that write off over 15 years allows the buyer $40,000 per year of that goodwill for each of the next 15 years. For 10 years of the loan payment, the buyer has a write off of $40,000 for the goodwill and must report $60,000 of principal each of those years for a taxable amount of $20,000 per year for 10 years ($60,000 principal payment that is not deductible minus $40,000 of goodwill that is). As the seller is getting his or her hypothetical gain which is treated as a capital asset, and has a 28% overall tax rate, the buyer reports $20,000 as ordinary income from the dental practice and pays a tax rate equaling close to 54%, or approximately $10,800 per year. That percentage includes the doubling of self employment tax of about 15%. The buyer is almost paying as much tax as the seller.
Additional information about the hypothetical transition takes place in the following paragraph.
There are many twists and turns along the way to the transition. The most important thing is to not lose sight of the goal, which is to have a successful transition of the dental practice and to be prepared for a different lifestyle if that is what the seller desires. If the selling dentist wants to continue working in the field, there are ways to resolve the issue of the tax for both the buyer and the seller. Of course, a general hypothetical description does not fulfill the understanding of what approaches are available to change the result of the large tax burden. Specific information and creative ideas can come from the dental CPA for both the buying and selling dentist.
As an idea to discuss with the dental CPA, the concept of the use of a retirement plan for the deferral of tax for both the buyer and seller should be something to spend time contemplating. For the experienced dental CPA with expertise in this type of undertaking, the potential to defer more than $100,000 for each the buyer and seller is certainly worth considering. There is almost always a tax to be paid but in understanding the concept of the use of the present value of a dollar, the CPA should be very helpful. To be more specific, if a dentist agrees to continue for a while, the seller would hypothetically maintain almost the entire $500,000 to invest while the buyer would defer the $10,800 per year until retirement.