by Bruce Bryen, CPA, CVA
When thinking of the dental practice and its value to the owner, one of the most important aspects of the worth of the practice is the amount assigned to the intangible asset goodwill. Besides the emphasis placed on goodwill and its appraisal as an item of significance, the differentiation between personal goodwill and the enterprise (dental practice) goodwill is an extremely critical point to consider. To define the amount of relevance allocated to each can be the difference between thousands of dollars to the owner when a transition occurs. This can be an associate acquisition or the outright sale to a hypothetical buyer after the practice is listed for sale and when the transaction eventually occurs. When planning the type of format for which the dental practice is organized, the entity decided upon has significance in terms of tax treatment that must be addressed. The allocation of the sale price in terms of asset importance regarding equipment, supplies, inventory and other items on the settlement sheet is what the advisors to the dentist will strive for in the hope of encouraging the capital gain tax treatment for the seller of the dental practice. Personal goodwill should be the lead in the thought process.
Goodwill and the entity format of the dental practice:
Besides all of the other considerations that a dental practice financial advisor or dental CPA may offer, the type of entity format is really one of the most critical. Here are some reasons and the type of business organization that affects the allocation of goodwill and what that assignment of the intangible means:
Other types of business entities used to organize a dental practice:
There are other types of business entities organized for dental practices such as hybrids of the above common dental practice formats and others. Which ever sort of business concept is used, it is important that an experienced advisor to dentists is retained to assist in the decision process. There is much at stake upon the eventual sale. This may occur years from the origination of the practice so the allocation of personal goodwill may be over looked when the time comes for the sale. A quick example in terms of dollars reflects what a mistake can mean to the owner who has worked his or her entire life and is now ready to retire comfortably after transitioning the dental practice.
An example of the dental practice transition using a hypothetical sale price:
Using a hypothetical sale price of $500,000 and ignoring state taxes which are similar no matter what type of business entity is used, the federal tax on the allocation of personal goodwill would be approximately 20% of the sale price, or $100,000. If $500,000 is the sale price and there is no personal goodwill, the allocation is probably ordinary income. The owner would most likely have the following tax scenario: There would be double social security and medicare on a portion of the sale price at $137,700 x 15.3%, or $21,068 in 2020. The portion of the medicare tax of 1.45%x2, as the owner, is unlimited so that after the $137,700 social security maximum taxable amount, the difference between that and the hypothetical $500,000, or $362,300 is taxed at the rate of 2.90%. That amount is ($362,300 x 2.9%) $10,507. There is one more self employment tax based on the amount earned in excess of $250,000, assuming the taxpayer is filing a joint tax return. In this hypothetical case the amount is an additional $112,300 x .9% or $1011. This all happens if there is no personal goodwill taxed at capital gains tax rates but at ordinary income rates. Besides federal income tax at approximately 35%, the owner upon the transition, owes an additional $21,068 plus $10,507 plus $1,011 or $32,586 and will be taxed on the gain at ordinary income tax rates and not at 20%, the capital gains rate. That taxable rate will be approximately 35% on the $500,000, or $175,000.
Analyzing the difference between a transition with personal goodwill and where there is no personal goodwill:
From the prior paragraphs, one can see that the capital gains tax where the allocation of personal goodwill is available, results in a tax of approximately $100,000, or 20% of the $500,000. When there is no personal goodwill and based on the type of entity format, the tax can be as high as $32,586 for self employment and medicare taxes plus an additional 35% x $500,000, or $175,000 in ordinary income tax. The tax without an allocation for personal goodwill is $207,586. It pays to consult with the dental CPA or financial advisor prior to deciding upon which business entity to use.