Selling Your Practice? Understand the Implications of a Sale Structure and Related Tax Considerations
The legal and financial implications that arise from selling your practice are quite significant. The implications of a sale will result first and foremost from the structure. Once the sale structure is determined, then the legal structure of your practice and the previous tax elections you have made will have a resulting impact. The sale structure can take one of three forms: a capital (or stock) sale, an asset sale, and/or a merger.
The Implications of a Capital Sale
A capital sale occurs when the buyer purchases the company shares from the seller. When the buyer purchases the company shares, the buyer is effectively purchasing all of the company assets and liabilities. Obtaining third party approval to sell the practice assets under this form of a sale is not usually required.
A buyer may prefer this approach if they want to continue to operate the practice uninterrupted. Furthermore, obtaining third party consent is usually not required to sell the practice. Still, this is generally not the preferred approach for a buyer because the buyer takes on the unknown liabilities of a practice, and the tax implications from this form may not be beneficial. On the other hand, sellers prefer this form of a sale because they can walk away from their practice relatively unencumbered, and the tax treatment for a seller tends to be the best under this form of a transaction.
The Implications of an Asset Sale
An asset sale is perhaps the most common form of a sale or affiliation transaction for medical practices. State laws that govern the corporate practice of medicine make it difficult if not impossible for potential buyers like local hospitals or nonphysician capital partners to buy a practice outright.
In an asset sale, the buyer and seller agree to buy and sell a list of specific practice assets. A market value is assigned to each specific asset. Some assets may require a third party to approve the sale. For example, your practice may have a beneficial payor contract with a health insurer. Often, this contract cannot be purchased without the express approval of the insurer.
Buyers prefer this approach because they can avoid purchasing known and unknown liabilities that come with a practice. Instead, the liabilities remain within the selling practice. Furthermore, the buyer often receives better tax treatment under an asset sale. However, this is not the preferred approach for sellers because they are left with potential liabilities for which they will be responsible. In addition,, the tax treatment may be less favorable.
The Implications of a Merger
When two or more medical practices want to come together, they can do so through a merger and together they create a unified ongoing practice. Similar to a capital sale, the assets and the liabilities of each of the merged practices become the assets and liabilities of the new ongoing practice. There are several legal forms a merger can take, and each have their own legal and tax consequences.
Medical practices can be taxed as C corporations or as S corporations. C corporations are subject to double taxation: first, the earnings of the corporation are taxed at the entity level and then when disbursements are made in the form of dividends, the disbursements are taxed at the personal level. For S corporations, the earnings of the medical practice are taxed only once at the personal level. When selling your practice, the extra tax burden a C corporation may face can result in a material reduction in net proceeds.
Stock sales typically result in capital gains for the seller, and for many physicians the capital gains are taxed at a lower overall rate than the ordinary income rate. For the buyer, the basis of the assets is set at the time of the sale, therefore the buyer does not get to step up the basis in the assets. Asset sales typically result in an advantage for the buyer, as they are able to step up the basis on the specific assets they are purchasing. For the seller, they recognize the gain or loss from the sale of each asset based on the difference between the sale price for the asset and the tax basis for the asset. If the seller is a C corporation, this can often lead to an increased tax burden. The tax implications of a sale are one of the compelling reasons that explain why sellers often prefer a stock sale and buyers often prefer an asset sale.
Additionally, previous tax elections can impact a buyer’s net proceeds. For instance, if a medical practice that converted from a C corporation to an S corporation sells within the ten- year built-in gain (BIG) window, the sale could trigger additional taxes related to the sale.
The implications of a sale of a medical practice are complex and nuanced. Moreover, the implications are often unique to each practice and are dependent upon the structure of the sale, the legal structure of the medical practice, and previous tax elections. These factors will have a material impact on the outcome of the sale. Furthermore, all of these factors create a unique fact set that requires an expert opinion to help the seller navigate. As a result, it is critical for a seller to identify legal representation and/or tax counsel to help navigate the sale process.
Considering selling your practice? Check out our other blog articles on selling your practice.