By: Bruce Bryen
Now that the dental school graduate has worked as an associate and feels that an understanding of the workings of a practice is known, he or she may be ready to acquire a dental practice. The knowledge of the clinical skills will be known only to the degree they were acquired while working as an associate.
A concern may be the administrative side of the practice. Especially if while an associate, the owner was less than open about teaching how to operate the business part of the dental practice. This is an important aspect of retaining profits and minimizing any losses that the office may incur.
The Importance of Hiring a Dental CPA
Hiring an experienced dental CPA will go a long way towards assisting with the record-keeping that is so important to the functioning of the organization. The hiring process of the dental CPA is something that needs to be accomplished before the potential for acquiring the practice begins.
Revealing the goals of the dentist, the financial background, including the credit standing, is a must for the dental CPA to understand about his/her client prior to beginning the search for the practice.
The dental CPA should be given the opportunity to explain what the selling dentist will want from a business structuring approach and how that will affect the buyer.
There should not be any surprises about the acquisition and how the final accounting will appear when the new owner’s taxes become due.
Taxes on Buying a Dental Practice
Take a look at various scenarios of transition and its effect on the buyer and seller of the dental practice.
What does the seller want from a structuring approach?
The dental CPA will tell his or her, client/ doctor, that the seller will almost always want to receive capital gains treatment upon the transition. This is because a capital gain will allow a seller to obtain the lowest tax rate upon the sale.
The difference in rates can be almost double to the seller if the income from the sale is reported as ordinary income, compared to the capital gains treatment that the seller may insist upon.
Capital Gains vs. Income Tax
As an example, disregarding state taxes, capital gain to a seller will probably be a federal tax rate of about 20%. This is compared to normal income reported from the earnings of the practice which may be as high as 50% for the owner when double Social Security tax and double Medicare tax are added to the top rate of federal income tax.
This is because the owner pays both halves of social security and medicare tax compared to what the associate may have been paying as an employee working for someone else who pays one part of each tax while the employee pays the other half.
Specifically, in 2022, maximum earnings for Social Security tax will be the highest they have been in its history at $147,000. The employee pays 6.2% and the employer pays 6.2% but as the owner, he/she pays 12.4% since they are both the employee and the owner.
Medicare tax is 1.45% for the employee and it’s the same for the owner so the owner effectively pays 2.9%. When wages exceed $200,000 there is an additional tax. If the top federal tax rate is added to the 12.4% plus 2.9%, one can see that the owner’s tax rate will exceed 50% compared to the 20% capital gains rate for the seller of the practice who reports the sale as a capital gain.
What does the buyer want as a structured approach to the transition?
As the seller wants a capital gains treatment upon his or her transition because of the low tax rate attributed to capital gains tax treatment, the effect upon the buyer is quite the opposite of that obtained by the seller.
This means that the seller pays a tax of about 20%, and the buyer pays an effective tax rate of nearly 50% unless there is substantial planning and steps taken to overcome this problem upon the acquisition of the dental practice.
This example reflects how the payment is made to the lender who has financed the acquisition for the new owner:
Suppose the sale price was $1,000,000 and the buyer was paying the bank at the rate of $100,000 per year in amortization. Where does the $100,000 come from for the buyer to pay?
The dental practice receives a certain amount of patient revenue and pays certain bills with its revenue. Dental supplies, lab fees, rent, etc., are all deductible items. The payment on the amortization portion of the loan is not deductible without some planning. That means that to have the $100,000 that is not deductible, those funds must come from the patient revenue and a tax has to be paid on those funds, without proper planning.
If the prior example is reviewed, one can see that with double Social Security tax and Medicare tax to the owner equaling 12.4% plus 2.9% when added to the federal income tax, the buyer is past 50% in a tax rate, not counting state taxes.
What does a buyer do to reduce this?
Invest in a Dental CPA
An experienced dental CPA will be able to accommodate the seller and still assist the buyer of the dental practice.
The important thing for the buyer is the acquisition of the dental practice. The dental CPA is someone who understands that objective and will create a plan that will not injure the buyer financially.
It will enable the buyer to buy the practice and minimize his or her taxes while still affording the seller the capital gains treatment that he or she will insist upon. The buyer should definitely find out who to retain to assist in reviewing financial information and in understanding the details to allow a smooth transition to occur.
Photo by Tara Winstead