As a dental practice sales consultant, I’ve seen firsthand how tax considerations can significantly impact the outcome of a practice sale. Understanding the tax implications of selling your dental practice is crucial for maximizing your after-tax proceeds and avoiding unexpected liabilities. In this guide, we’ll explore the key tax considerations every dentist should be aware of when contemplating a practice sale. NOTE: I am not an accountant so please speak with a professional about tax strategies and tax expectations.
Asset Sale vs. Stock Sale
The structure of your practice sale can have a substantial impact on your tax liability. Most dental practice sales are structured as asset sales, but it’s important to understand both options:
Asset Sale:
In an asset sale, the buyer purchases individual assets of the practice (equipment, patient records, goodwill, etc.). This is typically preferred by buyers as it allows them to depreciate the assets and potentially reduce their tax liability. For sellers, an asset sale often results in a combination of ordinary income and capital gains tax treatment. The allocation of the purchase price among different asset categories can significantly affect your tax bill.
Stock Sale:
If your practice is incorporated, a stock sale might be an option. In a stock sale, the buyer purchases the shares of your corporation. This structure is often more tax-advantageous for sellers, as it typically results in capital gains treatment for the entire sale price. However, buyers are often reluctant to pursue stock sales due to potential inherited liabilities and less favorable tax treatment on their end.
Understanding Capital Gains vs. Ordinary Income
The tax rates applied to your sale proceeds will depend on how the IRS classifies the income:
Capital Gains:
Long-term capital gains (for assets held more than a year) are typically taxed at lower rates than ordinary income. As of 2023, these rates are 0%, 15%, or 20%, depending on your income level. Most practices will be at the 20% level.
Ordinary Income:
Proceeds classified as ordinary income are taxed at your marginal tax rate, which can be as high as 37% for high-income earners. In a typical dental practice sale, the proceeds are often split between capital gains (for goodwill and appreciated assets) and ordinary income (for equipment and supplies).
Allocation of Purchase Price
The allocation of the purchase price among different asset categories is a critical aspect of the sale that can significantly impact your tax liability. Common categories include:
- Tangible assets (equipment, furniture, supplies)
- Patient records
- Covenant not to compete
- Goodwill
Goodwill often represents the largest portion of a dental practice’s value and typically receives capital gains treatment. However, items like equipment and supplies are usually treated as ordinary income.
Negotiating a favorable allocation with the buyer can help minimize your tax liability. However, be aware that the IRS requires both buyer and seller to use the same allocation in their tax reporting.
Installment Sales and Tax Deferral
If you’re receiving payments for your practice over time (an installment sale), you may be able to defer some of your tax liability. Under an installment sale, you generally pay taxes on the gain as you receive payments, potentially spreading your tax liability over several years.
This can be particularly beneficial if the deferred payments would otherwise push you into a higher tax bracket in the year of sale.
State Tax Considerations
Don’t forget about state taxes. Depending on your location, state capital gains taxes can add significantly to your overall tax bill. Some states offer more favorable tax treatment for business sales than others, which could impact your net proceeds.
Potential Tax-Saving Strategies
- Qualified Small Business Stock (QSBS): If your practice qualifies and is structured as a C-corporation, you might be eligible for a significant capital gains exclusion under Section 1202 of the tax code.
- 1031 Exchange: While not common in dental practice sales, if you’re reinvesting in another practice, a 1031 exchange might allow you to defer capital gains taxes.
- Charitable Remainder Trust: In some cases, transferring practice assets to a charitable remainder trust before the sale can provide tax benefits and income over time.
The Importance of Professional Guidance
Given the complexity of tax laws and the significant sums involved in dental practice sales, it’s crucial to work with experienced professionals. Your advisory team should include:
- A dental-specific CPA who understands the nuances of practice sales
- A tax attorney familiar with healthcare transactions
- An M&A Advisory Firm to facilitate and coordinate the process
These professionals can help you structure the sale to minimize tax liability and maximize your after-tax proceeds. FortyOneThirteen can provide introductions to reputable professionals involved in this process.
Planning Ahead
The key to managing the tax implications of your practice sale is planning ahead. Ideally, you should start tax planning several months in advance before you intend to sell. This gives you time to implement strategies that could significantly reduce your tax liability.
Understanding the tax implications of selling your dental practice is crucial for ensuring you retain as much of your hard-earned equity as possible. While taxes are inevitable, proper planning and structuring of your practice sale can make a substantial difference in your after-tax proceeds.
Remember, every practice sale is unique, and tax laws can be complex and subject to change. As your dental practice sales consultant, I always recommend working closely with tax professionals who can provide advice tailored to your specific situation. With the right team and proper planning, you can navigate the tax implications of your practice sale confidently and achieve the best possible outcome for your financial future.
