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The LaMaster Law Firm Blog

Thursday, July 6, 2017

How To Sell Your C-Corporation Dental Practice

At a time where many dentists are preparing to sell their practice, it is more important than ever to become informed on the process of selling a dental practice.  While there are a number factors to consider, one of high importance for the seller is the tax implications when organized as a C-Corporation. This article will provide a general "plain language" discussion of the most common questions and concerns relating to the issue of selling your dental practice as a C-Corporation.

How are C-Corporations Taxed?

A C-Corporation is subject to what is often referred to as the "Double Tax." This is because a C-Corporation is a separate taxable entity from the individual.  Therefore, profits are initially taxed at the corporate level at year-end, and again they are taxed if and when those profits are distributed to shareholders as dividends.

If your business is setup as a C-Corporation and you are considering selling your dental practice, you need to start planning as early as possible.  This is because this same "Double Tax" will likely be applied to the proceeds of your sale and can cost you tens or hundreds of thousands of dollars when you sell.

When a C-Corporation sells assets, the corporate Double Tax may apply.  As discussed, this will result in your assets first being taxed at the corporate level (taxed at a federal rate of approximately 35% in a professional service corporation). Upon distribution of the after-tax proceeds to the doctor as a dividend, a second tax is imposed on the doctor’s personal return. To illustrate this concept, if you have a dental practice worth $100,000 that is taxed at 35% you are left with $65,000.00, now since you will likely be cashing in your dividends, Uncle Sam could then take an additional 23.8% (maximum capital gain rate of 20%, plus the 3.8% net investment income tax) ($15,470.00), leaving you with a grand total of $49,530.00.  These are approximate numbers, and every situation is different; but, as discussed below your tax implications will be much higher here than if you can show that you've built personal goodwill and can sell it personally as a separate asset.

What about Personal Goodwill?  

As a C-Corporation, the IRS may find that all of the goodwill you've built as the owner may be determined to belong to your company, rather than you.  Generally, goodwill is defined as an intangible benefit acquired by a business through its reputation and patronage from repeat customers, patients, or referral sources.  Specifically, personal goodwill is goodwill that is owned by the shareholders of the corporation, rather than by the corporation itself. Personal goodwill exists when a portion of a company’s intrinsic value is directly related to the expertise, knowledge, reputation, technical skills, customer contacts and business relationships of a given shareholder.

In the sale of some C-Corporations, the principal or shareholder may have created "personal goodwill" through their own independent actions. If so, the personal goodwill may be sold as a distinct asset aside from the company's assets and will result in a lower tax burden for sellers.  For this reason, it is highly recommended for sellers to have an independent appraisal of their personal goodwill prior to the sale. This will help to minimize tax liabilities and maximize profits.

Personal goodwill, if accepted by the IRS, creates long-term capital gains to the shareholder, taxable at up to 23.8%. Conversely, if the asset is not categorized as personal goodwill, the ordinary income rate which is taxable at up to 35% is applicable, in addition to a secondary tax of up to 23.8% on the remaining balance of the purchase price once distributed. Accordingly, the selling doctor has an incentive to allocate as much as possible to personal goodwill to limit their tax liabilities to the one-time amount of 23.8%.  This means that if you have a dental practice worth $100,000 and you allocate $60,000 to personal goodwill and $40,000 to the corporation's assets, you could receive $45,720 after tax for your personal goodwill, and the remaining $40,000 of the corporation's assets would be taxed at the corporate rate of 35% and then the 23.8% leaving you with $19,812 after tax on the corporate sale.  The two numbers total $65,532 after tax.  That is much greater than the alternative above when there is no personal goodwill allocated to the sale.  Keep in mind that this is solely for federal taxes, depending on where you live, additional state taxes may apply. Also, in order to sell and allocate to personal goodwill, you must meet certain requirements, most of which are discussed below.  These requirements are derived from various case law and legal precedent.

What can I do to plan and protect myself on taxes?

  1. Eliminate the non-compete between you and your company.  You cannot have non-compete with your partner or your company.  A non-compete clause between you and the company is generally interpreted that the corporation owns the goodwill. Therefore, if you have an employment agreement with the company that includes a non-compete clause, you need to terminate the agreement or amend it to remove those and any other provisions that imply the corporation owns or controls the goodwill. This should be done as soon as possible.
  2. Emphasize and document the value of your personal relationships. During the negotiation phase, sellers should emphasize and document the value of his or her personal relationships with patients, employees, and referring sources, and document an intended allocation to personal goodwill, and support the allocation with an independent appraisal performed prior to the sale.
  3. Prepare the transaction documents to convey the personal goodwill value to the buyer. A few examples are to: send letters to patients and referring sources introducing and endorsing the buyer, personal introductions, and open houses. 
  4. Allocate a reasonable amount of the sales price to your post-sale non-compete and restrictive covenants. 
  5. Multiple Bills of Sale.  Often times, it is a good idea for the seller to include two Bills of Sale in the transaction. The first Bill of Sale is for your personal goodwill, and the second will be for the corporate assets.
  6. Consider restructuring your company. If you are considering selling your practice in the next 5 to 10 years, you may want to consider restructuring your company into an S-Corporation.
  7. Assisting with the transition. As many Seller's would like to assist the buyer in the transition of the practice, it's important to note that such an agreement should be made with the seller personally, not with the selling entity.

What's the bottom line?

To potentially save yourself a substantial amount of money, it is critical to plan ahead to see if you can sell your personal goodwill or convert to an S-Corporation.  You should always have the correct team (accountant and attorney) that specialize in dental practice sales to assist you.  It is not uncommon to begin preparation five or more years before you decide to sell.

The author, Matt LaMaster, is the principal attorney of The LaMaster Law Firm, PLLC, a boutique style law firm committed to delivering legal services to dental professionals and their practices.  For more information about Matt LaMaster and The LaMaster Law Firm, PLLC, visit www.lamasterlaw.com. This has been prepared for information purposes and general guidance only and does not constitute legal or tax advice. You should not act upon the information contained in this publication without obtaining advice from your attorney and accountant.





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