The legal structure of a dental practice transition caries unique advantages and disadvantages to both parties which should be carefully considered and negotiated. Most commonly, they are structured as either an asset purchase or a stock purchase. An asset sale transfers some or all of the assets of the business in a series of transactions. A stock sale is the transfer of an ownership interest from the seller to the buyer, with all of its incumbent benefits—and liabilities.
Since each structure has unique tax and liability implications for both the seller and the buyer, parties to the sale should clearly understand the differences between the two. The financial and legal interests of each might be best served by one over the other, and they may be (and typically are) in conflict.
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Buyers and sellers must "strike a deal" on whether to structure the transition as an asset vs stock purchase.[/caption]
Asset Sale: Overview
In an asset sale, the buyer purchases some or all of the assets
of the dental practice. That includes tangible assets like equipment, inventory and, possibly accounts receivable. Asset purchases also include intangibles, such as goodwill, non-compete agreements, or client records. In simple terms, Goodwill is the positive reputation and “brand” of the dental practice. Goodwill is quantifiable, both in the purchase price of the practice and in tax considerations. After the asset sale, the seller and buyer may choose to create a new legal entity
to continue the practice together.
Asset Sale: Tax Implications
Because of tax considerations, buyers may prefer an asset sale, while sellers would opt for a stock sale. In an asset sale, buyers can take depreciation deductions on the assets to lower taxable income. While the buyer will be able to take deductions on assets like equipment and goodwill through depreciation
, respectively, the depreciation period is much shorter. This permits buyers to take a bigger tax deduction in the few years after purchase, freeing up the cash flow of the business. It is also possible (yet seldom recommended) for the buyer to use Section 179
and bonus depreciation on these assets further reducing their tax liability.
On the other hand, sellers pay the ordinary tax rate on the sale of equipment and other tangible assets, and long-term capital gains tax rate on the sale of Goodwill and other intangible assets. This causes buyers and sellers to be at odds as the buyer prefers more of the purchase price be allocated to tangible assets since those will be depreciated faster, and the seller prefers more of the purchase price be allocated to intangibles since those will be taxed at the lower, capital gains rate. The spread between ordinary and capital gains tax rate can be (and often is) significant since the seller will generally have a lot of taxable income in the year of sale pushing their ordinary tax rates into the top brackets. Note that the amount of purchase price allocated to tangible and intangible assets can be flexible, but should be agreed upon in writing by both parties and reported to the IRS on Form 8594.
In a traditional sale, sellers are taxed on the asset sale in the year it occurs. However, installment sales may reduce this burden by spreading payments, and therefore the taxable income from the sale, over multiple years. Under the installment method, the seller includes in income each year only part of the gain received, or is considered to have received. One caveat here is they have to pay taxes for gain on all tangible assets in the sale in year one, regardless of how much in installment payments they’ve received.
Asset Sale: Liability Implications
Buyers are typically protected from current and future liabilities, since only the assets of the practice, and not the actual legal entity of the practice, are purchased. Sellers retain the cash, short and long-term debt obligations of the practice, and any lawsuits which arise as a result of the practice’s operations prior to the sale occurring. In a dental practice, potential liabilities may include lawsuits from former patients, contract disputes and Occupational Health and Safety Act (OSHA) violations, among many others.
Stock Sale: Overview
A stock sale is simpler than an asset sale. The seller transfers his or her interest in the practice to the buyer. Unlike an asset sale, there are no separate conveyances for items such as equipment, leases and goodwill. The buyer simply takes the place of the seller in the ownership of the dental practice
. With that transfer of ownership, the buyer assumes all responsibilities, risks, rewards and benefits of the stake in the business, unless specifically excluded in the purchase agreement or other legal document. Generally speaking, this causes the buyer to take on additional risks since they can be on the hook for claims on the practice but can also provide some benefits. For example, retaining the same Tax ID may allow the practice to continue on favorable vendor/ insurance contracts which may not otherwise be available under an asset sale.
Stock Sale: Tax Implications
Sellers pay a capital gains tax rate on the proceeds of the sale. This can result in significant tax savings compared to an asset sale, in particular if the assets sold were depreciated. In an asset sale, sellers may be hit with depreciation recapture, which does not occur in a stock sale.
Buyers do not have the benefit of depreciation tax deductions in the event of a stock sale. As the business assets do not leave the practice, the new owner simply steps into the shoes of the seller, and assets continue to depreciate on the same schedule. Because of the possible tax savings for buyers by choosing an asset sale, they may prefer it over a stock sale, especially if the dental practice has significant depreciating inventory.
Stock Sale: Liability Implications
By taking over the seller's interest in the dental practice, the buyer automatically assumes all of the business' current and future liabilities, known and unknown. This can pose a legal risk to the buyer. However, a dental practice purchase agreement may be structured to protect the buyer from some liability. For example, the seller may be required, through the contract, to assume full liability for lawsuits that would otherwise affect the incoming owner.
Choosing Between a Stock and Asset Sale
Whether the sale of all or part of a dental practice should be structured as an asset or stock sale depends on several factors. Both parties would choose a structure that offers the lowest tax rate and ensures legal protections against liability. Because of the nature of an asset sale versus stock sale, buyers and sellers may have a different preference. That tension means buyers and sellers should obtain separate legal counsel
even if they are currently colleagues in the practice.
Those who want to sell or buy a stake in a dental practice, or its assets, should take time to evaluate both their short- and long-term interests. Today the vast majority of dental practice transitions are Asset Sales in order to reduce liability and avoid confusion about responsibility for settling claims. With the counsel of a lawyer and appropriate financial advisors, buyers and sellers can make the sound business choice.
-Greg Maravilla, CPA, CFO Advisor at PracticeCFO