Taxes and the Sale of a Healthcare Business

Stoneridge Partners | Taxes & Sale of a Healthcare Business: Tax structuring may be one of the most important financial components of selling. Proper structuring could be the difference in paying almost 50% to less than 30% of sale proceeds in taxes. However, configuring the right structure to minimize the tax impact may not be simple. In many cases, the best scenario for the seller may not be best for the buyer, possibly requiring a negotiation. Common tax structures include stock sale and asset sale.

Tax BracketLong-term
capital gains
rate
10 – 15%0%
25 – 35%15%
39.6%20%

Stock Sale

  • Simplest method of transferring ownership
  • Easier transfer of items, such as leases and licenses
  • Usually most advantageous structure for sellers
  • Most (if not all) proceeds pass to sellers/stockholders as long-term capital gains
  • Long-term capital gains are taken on the entire amount of the profit
  • C-Corporations are the legal “owning entity” of the company, so the purchase price may be allocated 100% to the stock sale.
  • Balance sheet items are taken at book value. Example: equipment purchased for $20,000, depreciated to $5,000. The buyer takes it at $5,000.
  • Buyer cannot re-allocated tangible assets to a higher figure and begin depreciating them all over again (step-up)
  • Buyer assumes all liability from past operations of the corporation.
  • Buyer may be responsible for lawsuits from the seller’s past operations.
  • Business price may be negotiated lower due to buyer running a higher risk of unforeseen liabilities.

Asset Sale

  • Most popular method with buyers
  • Empty corporation is left in the hands of stockholders
  • Buyer’s exposure to past corporate liabilities is reduced
  • Buyer can step-up (see Stock Sale above)
  • Large part of the sale is allocated to goodwill, which can be amortized (written off) in 15 years
  • Entire purchase price may be able to be amortized
  • Most used method for S-Corps
  • Most problematic method for C-Corps

Stoneridge Partners | Taxes & Sale of a Healthcare Business

S-Corporations

Because profits in an S-Corp pass directly to stockholders, corporate tax does not apply. The manner in which assets are allocated determine the tax rate. Normally, this will be a blend or combination of tax rates, capital gains, and ordinary income. Ordinary income may also carry self-employment taxes. This structure may be good for the seller, but not necessarily for the buyer.

The total amount allocated to assets should equal the total selling price of the business. Because there are many creative ways to allocate assets, advice from a seasoned tax professional is valuable.Items that would be allocated traditionally include:

  • Tangible Personal Property (trade fixtures, furniture, and equipment)
  • Leasehold Improvements: The portion that is attributable to the depreciation is ordinary income. Any portion that is in excess of the original cost is capital gain.

Tax on the $400,000 gain would be calculated with the $300,000 depreciation as ordinary income (recapture of depreciation) and the $100,000 profit above the original cost as capital gains. For buyers, the allocated amount becomes their tax basis and they can then depreciate per IRS schedules.

Tangible Personal Property Example

Original cost $500,000
Depreciation$300,000
Book Value$200,000
Allocated in Sale$600,000
Gain$400,000

C-Corporations

Under this structure, assets are sold – leaving the corporation intact. Any profit on the sale is taxed at the corporate tax rate, graduated up to 35%. Any cash disbursed to stockholders is taxed again as either dividend or long-term capital gain. There are various ways to reduce this tax obligation.

One method is to allocate assets to personal service contracts, such as non-compete and consulting agreements.Because these personal contracts are earned by the stockholder and not the corporation, proceeds can be disbursed directly and by-pass the corporation. Unfortunately, taxes on these proceeds are then treated as ordinary income, which are taxed at higher rates.

ItemOrdinary Income to StockholderCapital Gain to StockholderBuyer Can Amortize Over 15 yearsBuyer Expense After Its Paid Out
Non-Compete AgreementYesYes
Training/Consulting AgreementYesYes
GoodwillYesYes
InventoryYes *
Customer/Client ListYesYes

*to the extent the allocation is over the tax basis. Otherwise, since there is no profit, there is no tax. Buyer treats this as “cost of goods sold” upon sale of the product.

A better method is to demonstrate that the owner of the corporation is responsible for some of the goodwill (through skill, ability, integrity or personal relationships). Then, it may be possible to allocate a portion of goodwill directly to that individual stockholder (capital gain) and by-pass the corporation. Because goodwill is most likely a sizable portion of the value, this can provide great tax relief. Goodwill can be amortized, while stock cannot be written off at all.

Stoneridge Partners | Taxes & Sale of a Healthcare Business: This article has been written by Stoneridge Partners with the understanding that neither the author nor Stoneridge Partners is rendering legal, accounting or other professional advice and assume no liability whatsoever in connection with its use. Please consult with a CPA or other tax professional for further information and advice.

Stoneridge Partners | Taxes & Sale of a Healthcare Business