Understanding the Allocation of Assets and Minimizing the Tax Liability in a Practice Sale

If you would like to minimize the tax costs on your future sale, you will need to understand what components of the sale create what type of tax. For example, under current tax laws, the highest regular tax rate (37%) will be higher than the capital gains tax rate (20%). So, the idea here is to allocate as much of the sales price allowed by law, to Goodwill (capital gains tax rates), as opposed to fixtures, furniture, and equipment (ordinary income tax rates) for a seller.

 

IRS Asset Classification for Dental Practice Sales

Below is a list of such assets and how they are categorized by the IRS.

 

Ordinary Income                                        Capital Gains
Equipment                                                         Goodwill
Furniture & Fixtures
Computers
Leasehold Improvements
Consulting Agreement
Dental Supplies
Covenant not to Compete

 

IRS Allocation Requirements and Strategy

Please keep in mind, the Internal Revenue Service (IRS), has a “pecking” order on how to allocate the sales price of your dental practice. The order of allocations starts with the “Hard Assets” (Ordinary Income) and concludes with the final allocation with the “Soft Assets” (Capital Gain).

So, using the above list as a guide and your knowledge on how to allocate the sales price to your benefit as a Seller, (in order to minimize the income taxes as a result of the sale), a majority of the sales price would need to be allocated to goodwill as opposed to fixtures, furniture, and equipment. Below, I will demonstrate the potential tax costs associated with the sale of a dental practice at $1,000,000

 

As you can readily see from the above, the blended tax costs are approximately 23% of the sale price of $1,000,000 ($234,000 / $1,000,000). The more of the sale price that is allocated to hard assets, the higher the tax costs to the Seller.

 

Negotiating Asset Allocation in Practice Sales

What needs to be negotiated between the parties is how much of the agreed-upon sale price is allocated to each asset type. As a rule of thumb, If we brokered ten deals, I would estimate that eight of the ten are going have 80% of the allocation to Goodwill (capital gains). This is mostly due to the fact that most of our sellers have offices with dated décor and equipment. If the practice has newer décor and excessive pieces of high-value equipment (e.g. CBCT, CEREC) then it may have a lesser allocation to goodwill and more to fixtures, furniture, and equipment.

 

Understanding the Buyer’s Perspective on Asset Allocation

Now, let’s flip the script – From the Buyer’s eyes, they want more of the allocation to fixtures, furniture, and equipment as opposed to goodwill that the Seller desires. So, you may ask yourself, why does the Buyer want more allocated fixtures, furniture, and equipment? The Depreciation / Amortization chart below will help you understand why this is the case.

Ordinary Income Property                          Capital Gains Property
Equipment (5 years)                                             Goodwill (15 years)
Furniture & Fixtures (7 years)
Computers (5 years)
Leasehold Improvements (15 years)
Consulting Agreement (immediate)
Dental Supplies (immediate)
Covenant not to Compete (15 years)

For example, the Buyer wants a majority of the Sales Price allocated to the Equipment, because it can be written off (expensed/depreciated) over 5 years as opposed to Goodwill which will be amortized over 15 years.

 

Internal Revenue Service (IRS) Requirements

When you Sell a Dental Practice, the IRS requires both the Buyer & Seller to disclose such, within their Income Tax Returns in the year of Sale. The information disclosed is: who is the Buyer, who is the Seller along with what was the Sales Price and how was the Sales Price was allocated. The IRS Form that requires such information is IRS Form #8594, Asset Acquisition Statement under IRS Code Section 1060”. If you would like to review such form, please go to: https://www.irs.gov/forms-pubs/about-form-8594.

 

Disclaimer: Doctor’s Choice Practice Transitions is not a Certified Public Accountant (CPA) firm, nor do we provide accounting, tax, or financial advisory services. Any information shared by our team is for general informational purposes only and should not be considered tax or financial advice. We strongly recommend consulting with a qualified CPA or tax professional regarding any financial, tax, or accounting matters related to your practice transition.