When purchasing or selling a dental practice, there are different ways the sales contract can be structured. The two most common ways are for either an asset sale or stock sale. There are different tax liability and legal liability implications for each type of sale. What may be good for the buyer may not be so good for the seller and vice versa.
In an asset sale, the buyer of the dental practice purchases all the assets of the practice, including both tangible and intangible ones. Tangible assets include the equipment, the building if it is for sale, rental and lease agreements, inventory, and accounts receivable. Intangible refers to the goodwill of the practice, which is quantifiable, the dental patient records, and non-compete clauses.
This main benefit of an asset sale to the buyer is he or she is not being obligated for any liabilities incurred by the sellers, like outstanding debts or lawsuits, whether lawsuits by patients or those by vendors and others for contract violations. Also, not purchased in an asset sale are penalties for health and safety violations based on events that occurred prior to the purchase of the practice.
In a properly written asset sale agreement, an asset sale is generally more beneficial to the purchaser since it gives them the opportunity to begin their new business without concern for prior liabilities.
During the due diligence process, attention must be given to what assets the buyer wants to include in the sales price. There may be a piece of equipment that appears to be an asset, but is in poor functioning order and will have to soon be replaced.
In an asset sale, buyers are generally protected from liabilities incurred by the practice from actions that took place prior to the sale. This is because the buyer is purchasing the assets of the practice and not the legal entity of the practice. For example, the buyer will not be liable for lawsuits filed due to damages from events that happened prior to the sale, or for fines imposed based on presale safety violations. These may include lawsuits by patients, vendors for contract violations, or even for violations of the Occupational Health and Safety Act (OSHA).
Buyers generally prefer an asset sale of a dental practice since they can take depreciation and amortization deductions on the assets, which lowers their taxable income. When buyers can take bigger tax depreciation deductions on the assets during the first few years, cash flow is increased. This allows the new owner to invest back into the practice while building it up.
Sellers are taxed on the assets the year they are sold. They pay the ordinary tax rate on the sale of the tangible assets which varies depending on the individual seller’s tax bracket. Intangible assets, like goodwill, is taxed at a lower rate as capital gains.
If the sale is of a C-corporation, the seller will face double taxation. The corporation is taxed when selling the assets. Then, the individual seller is taxed when the funds are transferred to him or her from the corporation.
The tax implications for an asset sale creates a dilemma. Buyers prefer to allocate more money to tangible assets in order to take advantage of depreciation, whereas Sellers may want to allocate more to intangibles in order to benefit from capital gains. Depending on the seller’s tax bracket, this can make a significant difference in his or her tax liability.
One way to help with this is in a carefully drafted purchase agreement. This allows the buyer and seller to allocate purchase funds to tangibles and intangibles. The agreement must be memorialized in writing.
There may be a benefit to both parties if the sale is paid for in installments. The buyer may benefit by spreading the payments over multiple years while the seller includes income each year as only part of the total gain received. The seller needs to consult with a tax professional to be sure that taxes are paid on the gain on all tangible assets in the first year of the sale.
A stock sale may seem easier because the buyer simply steps into the shoes of the seller. There are no separate conveyances of equipment, goodwill, or property leases, or any other assets.
The buyer assumes all the risks and benefits, including the responsibilities and rewards of the dental practice, known and unknown, unless specifically provided for differently in the written purchase agreement. This can be tricky, but at a minimum, the buyer should, by way of contract, require the seller to agree to be responsible for any lawsuits arising out of conduct or events that predate the purchase of the dental practice.
A stock sale benefits sellers tax-wise in that they pay capital gains on the proceeds from the sale of the practice. This may mean significant tax savings over an asset sale, especially if the assets sold had been depreciated.
Purchasers are at a tax disadvantage in that by stepping into the shoes of the former owner, the practice assets depreciate on the same schedule as they were depreciating for the seller.
There are many complex questions sellers and buyers of a dental practice need to have answered. Of course, both parties want to choose a structure that offers them the lowest tax rate while giving them the most legal protection against any liabilities. This tension means that each party should retain their own legal counsel so they can thoroughly evaluate what is best for them in order for them to each meet their own short-term and long-term goals and interests.
All possibilities must be thoroughly explored so neither party is later surprised. All potential tax and other liabilities need to be clear, so each party knows exactly what it is they have agreed to and how this agreement will affect their future.
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