According to Charles Schultz, a partner at Barnes & Thornburg, there are three major components that have to be considered in the sale or purchase of a practice.
Smart Business spoke with Schultz about the tax benefits and precautions in such sales. He spoke about the three parts of a practice and how both buyer and seller can benefit if they are willing to negotiate.
What is a practice?
A practice is composed of three assets. The first part is the furniture, fixtures and equipment. This includes exam tables, desks, chairs and medical equipment. These are considered the hard assets.
The second part is the accounts receivable. This means all of the money that is due to the practice from services provided prior to the sale. There are [normally] five to six months worth of services provided that have yet to be collected because of a delay in insurance coverage. Receivables can be a large asset.
The third asset is called the goodwill or intangible asset. That is defined as the name or reputation the practice has among patients or other physicians. This is the word-of-mouth reputation that makes the practice valuable.
How can a physician receive a tax break by breaking down the practice into three parts?
We use book value to declare the value of the hard assets. The book value is the purchase price of the equipment less the depreciation the practice has taken on the equipment. You want to allocate the purchase price to the assets that are depreciated as quickly as possible. Furniture and fixtures are depreciated over five to seven years. Other assets are amortized over a longer period of time. Therefore, it is necessary to allocate your price to be able to recoup your purchase price for tax purposes in the shortest period of time.
There are two options with the receivables. First, the buyer does not purchase the receivables. Instead, he or she distributes them to the seller, and the corporation pays a deductible compensation. Another option is for the buyer to purchase the receivables and then distribute them as deductible compensation. This can be compared to taking a loan from the seller, and instead of paying a lump sum at the sale working out an agreement where the receivables are paid over a number of years to the seller. This offers a tax break, because compensation is tax deductible.
The goodwill asset also can be a substantial amount of money. To receive a tax break, one should pay that amount of money as a severance benefit. This is deductible to the corporation and not taxable to the buyer. This makes taxes for the seller a little higher because it becomes an ordinary income tax, but a seller can increase the cost of the goodwill to balance this amount.
What should a physician be aware of when selling a practice to a corporation?
Most practices are owned by corporations, many of which are C Corporations. If you sell a practice to your C Corporation, most sales are going to be charged with a double tax. This is a negative aspect, because one ends up being charged at the corporate level and then again at the income tax level. This does not benefit the buyer or seller because the major portion of money is being paid in taxes instead of going to the physician.
How can a physician buy a medical practice?
There are two ways to purchase a practice. The first way is to buy stock in the corporation. From a tax perspective, purchasing stock is often problematic. If someone buys stock, you will want to structure the purchase price as a payment to him or her for something other than stock. This means paying the receivables and goodwill as compensation or severance pay as mentioned previously.
Another risk of purchasing stock involves liabilities. The seller must be honest at the sale to disclose any liabilities, but there is still a risk of malpractice suits and things yet to be filed. The benefit of this purchase is that any contracts, deals or agreements that exist in the practice are honored if the entire stock is purchased.
The other option is to buy the assets of the practice from the physician directly and allocate something that gives you the quickest tax benefit possible. Compensation is immediately deductible. Therefore, you will want to characterize as much of the purchase price to the seller as the severance benefit or compensation for services already provided to receive a deduction. Allocating assets that depreciate faster creates better tax benefits.
CHARLES J. SCHULTZ is a partner at Barnes & Thornburg LLP. He is a member of the Healthcare Department. Reach him at (312) 214-8305 or charles.schultz@BTLaw.com.