Tax Planning for Selling a Dental Practice

Are you considering selling your dental practice?  If you are, then maybe you are wondering what the tax implications might be for the upcoming sale.

As you prepare to sell your dental practice, you want to make sure you maximize your dental practice value and minimize your tax obligations.

You do not want to be surprised by post-sale financial responsibilities, in particular after taxes. 

Tax Considerations for Dental Practice Sale 

Typically, when dentists go about selling their practice, they will sell their practice for a lump sum of money. Although this type of sale means they are selling the practice, they are in actuality selling the assets of the business. These assets include dental and office supplies, equipment, and patient records. What also is included in the dental practice sale is a non-compete covenant. 

The IRS requires that the sale price be allocated among the different assets sold. If there is money that remains after allocating the price to the assets, the remainder is categorized as goodwill and can be considered as the value the seller has added to the practice. Also keep in mind that the sale of various assets creates different types of income so the allocation of the sales price could impact the seller’s taxes. 

When you sell supplies, that produces ordinary income.  That can be as much as 50 percent, depending on the seller’s tax bracket. The sale of your patient records, which is the non-compete covenant, along with the goodwill, are taxed at long-term capital gains rates. They max out at approximately 30 percent when state and federal tax rates are combined. 

The sale of your dental practice equipment could lead to capital gain income, however, it usually generates primarily ordinary income from the recapture of depreciation taken in earlier years. 

As the seller, your goal is to allocate as much of the purchase price as you can to patient records and goodwill, and just a minimum amount to equipment and supplies. 

Tax Implications as They Relate to Your Dental Practice Structure 

What is highly relevant and important when entering into a sale of your practice is knowing how your dental practice was originally established. So, if your practice was structured as a C Corporation – C Corporation profits are taxed separately from the owner – all income from the sale is taxed at the corporate level. It is worth noting that the federal corporate tax rate is about 34 percent, or 35 percent for income that exceeds $335,000.  

Conversely, if your dental practice was established as a regular partnership – typically a limited liability company or limited liability partnership – S Corporation, or sole proprietorship, the sale has ordinary and capital gains income taxes that are paid by the owners on their personal income tax returns. 

Maximizing Your Dental Practice Value

In order to maximize the value of your dental practice, it necessitates strategically placing the majority of the practice sale income in assets taxed as long-term capital gains. For the majority of sales, the value of the practice is primarily comprised of the goodwill of the practice, which could reduce the amount of taxes owed following the sale of the dental practice. 

When it comes time for the sale, it is important to remember that a dental practice is composed of several different types of assets, as mentioned earlier, and they include supplies, equipment, real property, and goodwill. Each of these assets calls for separate accounting and tax rules. This is because the IRS has established distinct depreciation and time factors for each practice asset. 

Tax Opportunities When Selling Your Practice 

You could employ some creative thinking when selling your practice. For example, for the vast majority of sales, a compromise on the allocation of the purchase/sale price is reached somewhere in the middle. However, you could opt to do it differently. During situations that involve conflicting interests, you will find an opportunity. Creative allocation of the price could be a powerful negotiation tool. The allocation could be modified, for instance, in return for a higher or lower purchase price. 

What’s more, subsequent to paying taxes on the sale, the majority of sellers usually invest the remaining proceeds with the goal of securing a consistent source of income for retirement. Conversely, sellers could consider owner financing a portion or all of the buyer’s practice purchase. When sellers take this action, the seller functions in the role of the bank and permits the buyer to make payments over many years. Because the income from the sale is not received all at once, the seller typically remains in a lower tax bracket than he would be in if he received large sums of money all at once. 

You, as the seller, receive consistent payments, in addition to interest, over many years, and you will continue to stay in lower tax brackets.  What’s more, you can defer a majority of the taxes into future years.  You will also probably pay less taxes overall. In the case of default, you could always take the practice back and sell it again. 

In the meantime, banks are more than happy to issue loans to dentists, as their average default rate is only 1 percent. Dentists are considered low-risk customers. 

When it comes to the building that your dental practice is housed in, if you own the building, you could hold onto it when you sell your practice. Keeping the building and using it as a rental is smart as that will provide a consistent source of income that you might need during retirement. 

Over the years, you have been depreciating your building and then claiming a deduction for this on your tax return. If you decide to sell the building, the taxes will be paid on all gains recognized. Some of the gain will probably be as the result of appreciation of the building over the years. You can expect this gain to be taxed at the lower long-term capital gains rates. 

Any gain related to the depreciation taken in previous years will be taxed at higher ordinary income rates. Rather than feel soaked as a seller from paying your taxes from the year of the sale, you can take a different path that involves decreasing the taxable gain on the sale of the building to zero. If you, as the seller, opt to keep the building until your death, and then pass it onto your heirs, all of the depreciation you have taken over the years gets cleared.  Your heirs inherit the building at the fair market value at the date of your death.  They could then turn around and sell the building for its market value and pay zero taxes.  They might decide to rent out the building for many more years and take advantage of the depreciation deduction once again. 

Look to Drilldown Solution for Tax Expertise When Selling Your Dental Practice 

If you are thinking about selling your dental practice, we encourage you to partner with Drilldown Solution as we offer sound tax guidance and practical recommendations so you can take advantage of potential tax opportunities. Even though selling your practice all at once for a lump sum of money is the simplest way to do this transaction, it might not be the best way when it comes to tax implications for your dental practice. 

With education and support from our tax experts at Drilldown Solution, we can help you put together a creatively structured sale that could reduce your tax burden, potentially provide reliable cash flow for your retirement, and leave a lasting legacy for your children. 

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