Tax guide for buying a dental practice

By: Bruce Bryen

Now that the dentistry graduate has worked as an associate and feels that he or she understands the workings of a practice, he or she may be ready to acquire a dental practice. The knowledge of the clinical skills will only be known to the extent that they are acquired while working as an employee.

A concern can be the administrative side of the practice. Especially if, while an employee, the owner was less than open about teaching the business part of the dental practice. This is an important aspect of preserving profits and minimizing any losses the firm may incur.

The Importance of Hiring a Dental CPA

Hiring an experienced dental CPA will go a long way in assisting with the administration that is so important to the functioning of the organization. The dental CPA recruitment process is something that must be accomplished before the practice acquiring potential kicks in.

Revealing the dentist’s goals, financial background, including creditworthiness, is a must for the dental CPA to understand his/her client before starting the practice search.

The dental CPA should be given the opportunity to explain what the selling dentist wants from a business structuring approach and how that will affect the buyer.

There should be no surprises about the acquisition and what the final accounts will look like when the new owner’s taxes are due.

Taxes when buying a dental practice

View different scenarios of transition and its effect on the buyer and seller of the dental office.

What does the seller want from a structuring approach?

The dental CPA will tell his or her, client/physician, that the seller will almost always want to receive capital gains treatment upon transition. This is because a capital gain will allow a seller to obtain the lowest tax rate on the sale.

The difference in rates can be nearly double for the seller if the income from the sale is reported as ordinary income, compared to the capital gains treatment that the seller may insist on.

Capital Gains vs Income Tax

For example, excluding state taxes, the capital gains for a seller will likely be a federal tax rate of about 20%. This compares to the normal income reported from the practice’s income, which can be as high as 50% for the owner when double Social Security and double Medicare taxes are added to the top federal income tax rate.

This is because the owner pays both halves of Social Security and medical taxes compared to what the employee may have paid as an employee working for someone else who pays a portion of each tax, while the employee pays the other half.

In 2022, the maximum Social Security tax revenue will be the highest in its history at $147,000. The employee pays 6.2% and the employer pays 6.2%, but as an owner, he/she pays 12.4% as 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 actually pays 2.9%. If wages exceed $200,000, additional tax will be levied. If the top federal tax rate is added to the 12.4% plus 2.9%, it can be seen that the owner’s tax rate will be higher than 50% compared to the 20% capital gains rate for the practice seller selling the as an added value reports .

What does the buyer want as a structured approach to the transition?

Since the seller wants capital gains treatment on his or her transition because of the low tax rate attributed to the capital gains tax treatment, the effect on the buyer is the exact opposite of that of the seller.

This means that the seller will pay a tax of approximately 20% and the buyer will pay an effective tax rate of close to 50%, unless substantial planning is in place and steps are taken to resolve this issue in the dental practice acquisition.

This example shows how the payment is made to the lender who financed the purchase for the new owner:

Suppose the sale price was $1,000,000 and the buyer paid the bank with a depreciation rate of $100,000 per year. Where does the $100,000 the buyer have to pay come from?

The dental practice receives a certain amount of patient income and pays certain bills with its income. Dental supplies, lab fees, rent, etc. are all deductible. The payment on the repayment portion of the loan is not deductible without some planning. That means that in order to have the $100,000 that is not deductible, those funds have to come from the patient’s earnings, and tax has to be paid on those funds, without proper planning.

Looking at the previous example, one can see that with double Social Security and Medicare owner’s tax equal to 12.4% plus 2.9% when added to the federal income tax, the buyer is past 50% in a tax rate, the state not including 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 while still assisting the buyer of the dental office.

The most important thing for the buyer is the acquisition of the dental practice. The dental CPA is someone who understands that goal and creates a plan that won’t hurt the buyer financially.

It will allow the buyer to buy the practice and minimize his or her taxes, while still giving the seller the capital gains treatment he or she insists on. The buyer needs to be sure of who to keep to help review financial information and understand the details to allow for a smooth transition.

Photo by Tara Winstead

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