Understanding these key issues keeps more money in your pocket than Uncle Sam’s
Small, independent medical practices once dominated the medical landscape. But doctors are increasingly giving up their independence to join larger groups or hospital systems that eliminate the headaches of running a business in today’s health care climate.
2016 marked the first time ever that less than half of practicing physicians in the U.S. held ownership stakes in their practice.
But whether you’re ready to retire or accepting a buy offer, selling your medical practice can lead to a hefty tax bill if you’re not careful. And in the highly regulated health care industry, it’s easy to get so caught up in business and contractual terms that you overlook the tax implications of a practice sale that may affect you far into retirement.
Let’s take a look at some of the key tax issues you need to consider before you sell your medical practice.
How will you structure your sale?
Medical practices are typically sold through two types of transactions: asset sales or stock sales. Different tax advantages and disadvantages surround each option, and which one you choose also depends upon the corporate practice of medicine (CPM) and fee-splitting laws in your state. If your state permits non-physicians to own a physician practice, you have much more flexibility to choose how you want to structure your sale no matter who your buyer may be.
- Stock sale. A stock sale is what most people envision when they talk about selling a medical practice: the buyer buys the practice with the intention of taking over the role of the doctor who’s selling. The buyer purchases the previous owner’s equity in the practice, as well as its assets and liabilities. Most or all of the accounts on the practice’s balance sheet are also included.
Stock sales can only be conducted entity-to-entity but can be done by any type of corporation, from C-corporations to S-corporations to LLCs.
Sellers favor stock sales because they enable them to completely cut ties with the practice and avoid any future liabilities that stem from it. They also enjoy the tax benefits: most stock sales are taxed at the long-term capital gains rate, which is capped at 20 percent. That’s because the practice’s stock is trading hands, and the gain is like a long-term stock gain for the sellers.
The increased risk of assuming the seller’s liabilities causes many buyers to shy away from stock sales. But others prefer them because they make it easier to assume third-party payor contracts and Medicare numbers.
- Asset sale. In an asset sale, the buyer purchases certain assets and liabilities of the medical practice – but not others – and the selling entity remains intact. Put simply, buyers can cherry-pick which assets they want – like a particular piece of equipment – and which liabilities they don’t, like pending litigation. Usually the majority of the seller’s assets are included in the deal, including patient lists and equipment.
Asset sales can be done by individuals or corporate entities.
Here’s the tax drawbacks for the seller: Many of the assets you sell will be taxed at ordinary income rates, which can climb as high as 37 percent, depending upon your individual situation. So, say you bought a desk for your office for $2,000, depreciated it over the past five years on your tax returns, and then valued it at $500 on your list of assets during the sale. The difference between the fully depreciated asset ($0) and the sale price ($500) is taxable at ordinary income rates. Multiply that out over all of your fixed assets, and you can see how it starts to get pricey.
Incidentally, special attention should also be paid to the portion of the purchase price that’s allocated to your practice’s non-compete agreements, which many people don’t realize will also be taxed at an ordinary income rate.
Now read this carefully: In most practice sales, the majority of the value of the practice comes from intangible assets like goodwill, which is taxed at long-term capital gains rates. Sellingapractice.com defines goodwill as “the value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology.”
During negotiations, sellers will want to lower the value of their tangible assets and amplify the goodwill, and buyers will want to do the opposite. That said, the IRS and health care regulatory requirements insist that the value a practice sets for its tangible assets is based upon fair market value at the time.
Why your corporate structure matters
The way your practice was incorporated also has important tax implications during a sale. C-corporations are subject to double taxation: income is taxed once as earnings, and then shareholders are taxed again when the earnings are distributed. S-corporations are only taxed once to the shareholders.
If the selling practice is a C-corporation, the double taxation can cause asset sales to result in a nasty tax burden. In those cases, selling the business in its entirety through a stock sale is usually a better choice because it only results in one tax bill.
Sole proprietorships can only be sold through asset sales.
So, what does all of this really mean?
The purchase price of asset sales is broken down into different classes of assets: goodwill, non-compete agreements, tangible assets, intangibles like intellectual property – all of which are taxed differently by the IRS. The way the price is allocated among these asset classes has significant tax implications and should be a major negotiating point for both parties.
For tax purposes, asset sales generally benefit buyers. By maximizing the purchase price of assets that depreciate quickly (equipment) and minimizing the value of assets that depreciate slowly or not at all (goodwill), a buyer can reap tax benefits from the purchase price because they can write off the depreciable assets they acquire over future years. Goodwill must be amortized over 15 years.
Thanks to the new Tax Cuts and Jobs Act, Section 179 of the IRS tax code also allows businesses to write off the entire purchase price of qualifying equipment of up to $1 million in the year they buy it – with a total spending cap on equipment purchases of $2.5 million. For taxable years beginning after 2018, those caps will be adjusted for inflation.
Doctors who sell, on the other hand, receive a taxable gain or loss that’s based upon the difference between the sale price of their practice and the tax basis of its assets and liabilities. By the time the assets are sold, much of the practice’s equipment was most likely fully depreciated for tax purposes – so any amount that exceeds its book value will be taxed at an ordinary income rate.
The bottom line
Hospital systems are aggressively snapping up physician practices nationwide, and you shouldn’t wait until you receive a buy offer to start researching the kind of deal you want. Selling a medical practice can be extremely complex – and it’s easy for even the most financially-savvy doctors and their attorneys to make mistakes that carry long-term tax implications. Remember, if one component of the deal is good for you, it’s probably not good for the other side. An experienced certified public accountant can help you structure a deal that keeps the most money in your pocket, not Uncle Sam’s.
Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact in their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning, and to find out how we can help your business exceed your expectations.