Tax Consequences of Selling Your Dental Practice
Dental practice sales often represent the culmination of a long and successful career or progression onto new pastures. Understanding the tax consequences of selling a dental practice is crucial to ensure a smooth and financially advantageous process.
Many dentists rely on the profits from selling their dental practice as a fundamental part of their retirement strategy. Minimizing tax exposure will ensure you can enjoy your well-deserved nest egg and your retirement—or whatever comes next—to the fullest.
Factors that Affect the Tax Consequences of the Sale
Numerous factors influence the profits you make on the sale of your dental practice. Getting help from tax planning experts is a must at this point, as the amount of tax you pay can vary significantly depending on the decisions you make before and during the sale.
Tax Implications by Business Structure
Your business structure and entity status will impact how your dental practice sale is taxed. Dental practices structured as a sole proprietorship, partnership, limited liability company (LLC), or S corp are subject to individual income tax and capital gains tax rates.
Dental practices structured as C corps are taxed on the sale of the business according to the corresponding corporate tax rate. This will be the fixed corporate tax rate of 21% plus your state’s corporate tax rate. The main disadvantage of selling as a C corp is the “double taxation” on shareholders that occurs, as the remaining cash from the sale will be distributed to owners and subsequently subject to individual income tax (after already having paid corporate tax on the same profits).
Asset Sale vs Stock Sale
One of the biggest decisions when selling a dental practice is whether to structure the deal as a sale of assets or stock. An asset sale will involve selling both tangible and intangible assets belonging to the practice. These could include equipment, patient records, and goodwill. A stock sale means selling the ownership interest in the dental practice.
The tax implications both for the buyer and seller vary depending on various factors. However, stock sales typically result in more favorable tax treatment for the selling party.
Allocation of Assets
Selling a dental practice invariably involves selling off various assets you've accumulated in your business over the years. Assets are categorized differently for tax purposes depending on what type of asset they are. For example, revenue raised from sales of supplies is counted as ordinary income and, as such, is subject to ordinary income tax rates. However, other sales would count as long-term capital gains. These include real estate and patient records.
When selling a dental practice, tax allocation negotiation plays a crucial role in determining the taxable gain or loss on the transaction. An expert in accounting for dentists can explain how various allocations of the purchase price between assets such as goodwill, equipment, and inventory will affect the seller’s tax liability.
How to Reduce Your Tax Liability Through Allocation of Assets
The IRS categorizes assets into seven different categories. These categories are subject to different tax rates. For example, Class IV assets are taxed according to ordinary income tax rates; up to 37%. Conversely, Class V and VI assets are taxed at more favorable capital gains tax rates.
A tax professional can advise you on how to categorize your assets strategically. Sellers who allocate the majority of the purchase price to categories with lower tax rates will face a lower overall tax bill.
Installment Sales
An installment sale enables the selling dentist to spread the recognition of taxable gains over several tax years. Doing so provides potential tax deferral benefits as installment sales minimize the immediate tax impact of the sale and allow the seller to manage their tax liability over time.
Installment sales are more complex than regular sales, meaning there may be aspects you haven't foreseen. For example, installment sales may be subject to interest charges or default provisions.
Remember that in an installment sale, the seller recognizes income in proportion to the yearly payments they receive rather than all at once. This reduces the immediate tax bill. However, take into account that interest on installment payments may be taxed as ordinary income. The seller must also consult a tax professional on what happens if the buyer defaults on payments and they need to recognize gains on the unpaid balance.
How Different Taxes Apply to the Sale
The financial outcomes of selling a dental practice will hinge upon the extent of your tax obligations. The profits from the sale will be impacted by:
Ordinary Income Tax
The ordinary income tax rate ranges from 10-37% for the 2024 tax year. How much you pay will depend on your income bracket and filing status. The sale of your dental practice will likely propel you into a higher tax bracket, resulting in a hefty tax burden. A tax professional can give you advice on how to maneuver more of the sale price into a lower capital gains tax bracket, where possible, for tax savings.
Short and Long-Term Capital Gains Tax
Capital gains taxes are paid when profits on an asset exceed its original purchase price. The differences between short- and long-term capital gains tax rates are significant and must be taken into account when selling assets from a dental practice:
The profits gained on assets owned for less than a year are subject to short-term capital gains tax. Short-term gains are taxed at the same rates as ordinary income.
Long-term capital gains receive much more favorable tax treatment. Profits on assets held for more than a year are subject to a 0%, 15%, or 20% long-term capital gains tax rate. The amount you pay will depend on your income tax bracket.
Selling your dental practice often involves selling real estate. Strategies to reduce capital gains taxes are one of the most important tax implications of selling business property and could have an impact on your tax bill.
How to Optimize Your Tax Liability on the Sale
Proper tax planning can reduce the tax liabilities for both parties. You may be able to reduce your tax bill by following these tips:
Always seek the advice of a tax professional: Tax professionals are well-versed in ways to optimize their clients’ tax liabilities. Navigating the many implications of such a large sale should only be undertaken with the assistance of a professional. They will help you optimize your tax bill and prevent missteps that could result in penalties.
Structure your sale smartly: Maximize the amount of profit subject to more favorable tax rates like the long-term capital gains tax rate. This can be achieved by allocating a smaller portion of the purchase price to assets subject to ordinary income tax rates.
Timing is of the essence: A tax professional can explain when the optimal time is to sell, depending on your financial situation.
Take advantage of deductions: Taking deductions can make a significant dent in your taxable income following the sale of a dental practice. Expenses such as broker or legal fees add up, and deducting them could significantly reduce your tax liability.
IRS Filing Requirements after the Sale
After the sale of your dental practice, you have several other obligations with the IRS. These are:
File your final tax return and any other related forms.
Pay any outstanding wages, benefits, or taxes related to your employees.
Pay any tax you still owe on business operations before the sale or on the sale itself.
Report any payments made to 1099 workers.
Cancel your employer identification number (EIN) and shut down your business account with the IRS.
Keep your records.
Patient Records and Confidentiality Considerations
Make sure you know the retention requirements for patient records in the state where you practice. Conduct all due diligence to protect your clients' patient data and protect yourself from any confidentiality breaches.
It’s wise to ensure that the contract of sale includes a clause that requires the buyer to keep your clinical records confidential. Give the buyer copies of your clinical records and keep the originals in a safe place in the case of a complaint or claim after you retire or sell your practice.
Set Yourself Up for Financial Security With Wise Tax Planning
Selling your dental practice is a significant milestone and one that requires detailed and careful planning. Taking on the sale alone isn't recommended as the tax considerations involved in large and complex sales are highly nuanced.
Secure your financial future for retirement or whatever's around the corner with the help of a tax professional who understands the significance of this transaction. Choose a trusted professional who will strive to direct every possible cent to your future by minimizing your tax liability.
