Tax Consequences Of Selling A Dental Practice (2024)
Amidst the excitement of selling a dental practice, it’s crucial to pause and consider the tax consequences that accompany such a transaction. Yeah, we know, taxes can be a buzzkill and not as exciting as extracting a stubborn molar or crafting a perfect bridge, but ignoring them can come back to haunt you like a stubborn toothache
Regardless of the type of practice – whether it’s a solo practice, partnership, or corporation, staying on top of tax affairs during the process of selling a dental practice is an indispensable measure to maximize your financial gains.
So, come along as we explore the intricacies of taxes surrounding dental practice sales, unveil strategies for minimizing tax liability, and provide valuable tips for tax planning.
Without further ado, let’s get started!
Factors That Influence Taxation When Selling A Dental Practice
Type Of Entity
Don’t brush this off as mere legal jargon—each entity type comes with its unique set of tax rules and regulations. Whether you have structured your practice as a sole proprietorship, partnership, limited liability company (LLC), or corporation can have varying implications on the tax treatment of the sale.
To expound on this:
If you’ve got it set up as a sole proprietorship, partnership, limited liability company (LLC), or S Corporation, when it comes to taxes, the money you rake in from the sale will be subject to the ordinary income or capital gains tax rates applicable to the respective individual.
On the flip side, if the dental practice is structured as a C Corporation, things take a different turn. In this scenario, the business itself will bear the tax burden for the sale, subject to the prevailing corporate tax rate.
Structure Of The Sale
The structure of the sale itself is another key consideration. An entity or asset sale?
Let us break it down for you in plain and simple terms:
In an asset sale, you sell individual assets such as equipment, patient records, and goodwill, while in a stock sale, shares of your dental practice entity are sold. The former is the option for selling dental clinics registered as a sole proprietorship or partnership.
Additionally, when it comes to an asset sale, the buyer gets to play the game of pick and choose – they can decide to opt for the assets they like. And here’s the kicker: they might not have to deal with any liabilities tied to those assets they snatch up. On top of that, buyers can write off big chunks of the sale once it’s all said and done.
As for practices that are registered as C-corp, they can either be sold as an asset or entity (stock sale). Here is the difference:
If they opt for an asset sale, a potential double whammy of taxation hits the shareholders. However, if they choose to sell the entire entity, by offloading the corporation’s stock, it is just a straightforward process and shareholders will dodge that extra tax bill but will assume the corporation’s liabilities.
But hold on. Now, here’s the deal:
In an entity sale, the buyer might be worried about the corporation’s financial obligations even those honestly unknown at the time of sale, for example, payroll tax deficiency.
Furthermore, the buyer is likely to have reservations about how the selling entity values its assets. Due to these factors, buyers tend to push for a lower stock price than what the sellers would ideally prefer. This very reason is why an asset sale is often advised, even for dental practices operating as C-corps.
Common Taxes And Their Rates In Dental Practice Sales
Ordinary Income Tax
When it comes to ordinary income, it is subject to taxation at the prevailing standard rates for the tax year 2023, which are 10%, 12%, 22%, 24%, 32%, 35%, and 37%, based on your income bracket and filing status. Now, here’s where things get interesting: the sale of a dental practice has the potential to swiftly propel a seller into a higher tax bracket, resulting in a hefty tax bill. Therefore, if feasible, maneuver income into a lower capital gains tax rate, which allows you to save on tax.
Capital Gains Tax
When you sell an asset and make a profit that exceeds its original purchase price, that’s what we call a capital gain. Meaning, you’re still on the hook for capital gains taxes whenever you purchase something and later sell it at a profit whether they depreciate with the passage of time or not.
Generally, we have two types of capital gains taxes:
- Short-term capital gains tax is a tax imposed on the profits generated from the sale of an asset held for less than a year. And guess what? The rate at which you’ll be taxed is just as brutal as the rate you’d pay on your ordinary income
- Long-term capital gains tax relates to assets held for more than a year and receives more favorable tax treatment, often resulting in lower tax rates. Depending on the income bracket – the higher it is, the more tax you pay, long-term capital gains tax rate is 0%, 15%, and 20%.
Tax Amount Payable By The Seller Following The Sale Of Their Dental Practice
The tax amount payable to the IRS by a dental practice seller in 2023 hinges upon the “assets allocation” in relation to the final purchase price.
Assets Allocation And Tax Implications
So far we can agree that regardless of the entity your practice is registered as, chances are high that you will be selling assets. The question that begs an answer is which assets will you be selling?
Let’s look to the IRS for answers – and according to the guidelines, assets can be classified into seven groups:
- Class I – Cash and general deposit accounts including checking and savings accounts; with the exceptions of “certificates of deposit held in banks, savings, and loan associations, and other depository institutions.”
- Class II – Actively traded personal property, such as stocks. “Class II assets include certificates of deposit and foreign currency even if they are not actively traded personal property. Class II assets do not include stock of seller’s affiliates, whether or not actively traded.”
- Class III – assets that the taxpayer marks to market at least annually for federal income tax purposes and debt instruments (including accounts receivable).
- Class IV – They are “stock in trade of the taxpayer or other property of a kind that would properly be included in the inventory of the taxpayer if on hand at the close of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of its trade or business.”
- Class V – are all assets other than Class I, II, III, IV, VI, and VII assets. They include buildings, equipment, furniture, fixtures, and vehicles.
- Class VI – Intangible assets minus goodwill or going concern value. Some examples are: Workforce in place; Business books and records, operating systems, or any other information base; customer-based intangible; supplier-based intangible; license, permit, or other right granted by a government unit; covenant not to compete; and any franchise, trademark, and the like.
- Class VII – Goodwill and going concern value.
Why should you care?
Price Allocation Impacts Tax Liabilities During Sales
To illustrate, assets falling under Class IV, such as inventory, are subject to ordinary income tax rates, which can reach up to 37%. On the other hand, Class V and Class VI intangible assets enjoy the sweet perks of more favorable capital gains tax rates. See the difference? It’s all about playing the tax game wisely.
In essence, a seller will be exposed to more tax liabilities if they allocate the bulk of the purchase price to categories subject to income tax and vice versa.
No matter how you slice it irrespective of the allocation, the federal income tax applies to the seller’s return and can range from a tax rate of 10% to 37%. That’s not all: if the seller decides to stick around as an employee or consultant, they should brace themselves for even more taxes – employment taxes such as Social Security and Medicare will also be levied.
Mitigating The Tax Bite
Nobody likes handing over their hard-earned cash to the taxman, right? So, let’s talk about how you can put on your tax-saving superhero cape and minimize the impact of Uncle Sam’s bite.
Consider the following advice:
- Seek the counsel of a tax professional. This is not a battle you want to fight alone. A seasoned tax professional can be your secret weapon, helping you devise a plan to minimize your tax liability.
- Structure your sale smartly. As a seller, the objective is to maximize the amount of profit subjected to a more favorable capital gains tax rate. How? The most effective approach is to allocate a smaller portion of the purchase price to the assets subject to ordinary income tax and allocate a larger portion towards goodwill that is subject to the more favorable capital gains tax rate.
- Timing is of the essence. Work closely with your tax professional to determine the optimal time to sell. Analyze your financial situation, project your income, and strategize accordingly.
- Don’t overlook deductions: Familiarize yourself with deductions specific to the sale of a dental practice. Expenses like broker fees, legal fees, and advertising costs can chip away at your tax liability, so make sure to take full advantage.
And there you have it, my dental practice owner extraordinaire.
As the curtain falls on our exploration, one truth remains crystal clear: taxation is an inseparable companion on this journey. Ignorance may attempt to shield us from its presence, but it is only when you embrace knowledge and seek professional guidance, you can unlock the power to make informed decisions and optimize your financial outcomes.
That said, may your dental practice sale be a roaring success, with a little extra cash in your pocket and a smile on your face.
The information provided in this article is for informational purposes only. Consult with a qualified tax professional for tax advice.