Tax Considerations During Transactions
Tax knowledge and tax strategies should be something that all business owners and prospective buyers need to keep in mind when preparing to enter into a healthcare transaction. The Ambulatory M&A Advisor opens up the world of various business structures and discusses some of the tax strategies that are involved during a healthcare business transaction.
Leigh Griffith partner with Waller Lansden, Dortch and Davis says that when companies are buying a facility and operation, usually, the amount paid for tangible personal property is a fairly small percentage of the final purchase price with the purchase being the “going concern” and tangibles.
“Under the tax code, if you can buy it in certain ways, you get to step up your tax basis and you get to amortize that over 15 years. Obviously, that amortization is worth money, so when we are looking at a potential transaction, one side of the house is doing the economic piece, but from the tax side the focus starts with what the form of the business entity is. You know the goals of the seller is to get preferably one level of tax in capital gain. Your goal is to get a step up from the tax side in the amortization,” Griffith says.
Grant Grayson, shareholder and partner at the law firm of LeClairRyan says that merely the structure of the acquired business is something that needs to be taken into account when analyzing the taxes of a business in the field.
Grayson says there are two main corporations that can be formed; C-Corporations and S-Corporations.
“Any company can be a C-Corporation, but the problem with the C- Corporation oftentimes with professional firms or small companies is that the corporation pays tax on its income and then if it makes distributions to its shareholders, then those are also taxable. The C-Corporation subjects the owners basically to double taxation,” Grayson says.
Grayson continues to explain that there are certain corporations that can elect “Sub Chapter S Status”,which means there is no tax at a corporate level and the shareholders are deemed to have earned the income that the corporation made.
“That is reported to them on a form K-1. Each shareholder would receive his share of the income earnedby the corporation and then pay those taxes at their personal tax rates. That’s on the corporate side,” Grayson says.
If the business entity is a C-Corp, Griffith warns that it will be very difficult to deal with. If the buyer purchases the stock, they will get a step up in basis of anything except basis of stock, which sits like a rock on a balance sheet. Of course, if one buys the stock they now have whatever liabilities are out there, disclosed or not.
“From the seller standpoint, if they sell assets, they are going to have a corporate level tax, and then they are going to have a shareholder level tax. Two taxes get to be real expensive. They look at it as a great price, but not really getting anything out of it at the end of the day. Those are tough to do, and on occasion, I have had to tell groups to do what they like, but they will most likely have to file an S selection and wait five years if they really want to get the kind of money they desire. Between not getting the tax benefit, and the inherent liabilities that may be unknown, it has a depressant on the price. You have got to decide if you are going to take more than you think it is really worth, or if you want to get into the environment where you can get a better price, both on the gross side and the net side,” Griffith says.
“If you have a practice being sold that does not get government money; then you look and see whether the owners have personal good will, meaning they have no non-competes, no claimant agreements and have patients really coming to them based on the fact that these physicians are there. If that answer is yes, you get appraisals and continue with the process, but I can buy your personal good will. I get my step up; I get my amortization, and that does not go through the corporation. In this situation, the individual gets capital gains, and that’s really nice.”
If government money is involved, Griffith says most buyers shy away from paying for personal good will. The primary concern is that it can be construed with buying referrals. Different buyers have different thresholds on that situation. Most of these deals have a lot of government money attached to them, and most of the bigger buyers really aren’t going to be receptive to buying personal good will because nobody really know where the feds are on it. If the buyers are a large organization making a purchase, they don’t want to find out later on that their risk tolerance is somewhat different than a private group doing the purchase.
Griffith says Most of the ASCs are either S-Corps or LLCs, and that gives latitude to get that tax step up.
“On the S-Corp you can buy the stock and make a 338 H 10 or 336 E tax elections. The H 10 is a corporate purchaser and the the 336 E is like an LLC buying an S-Corp. I get my step up, I keep the EIN and I bought the entity. The shareholder that is selling will have a mix of capital gain and ordinary income. Typically, the buyer will equalize them so that they don’t have a loss by the element of ordinary income,” Griffith says.
“Difficulties can arise in an S Corp when you do due diligence. You find out that maybe they haven’t done the things that the S Corps require, have one class of stock, or an ineligible shareholder, making them not actually an S Corp. There is a lot of due diligence done on that. It is surprising how many times S Corps have issues due to people not paying attention to the issues that qualify them to be an S Corp. If the buyer buys the company not knowing that it is not an S Corp, they have the past tax liability, the election doesn’t work, the bought stock in a liability for taxes, that’s not attractive, and leads to stress.”
There is a procedure to clean it up this issue but Griffith says it is expensive.
“You go to Washington, get a determination that situation will be okay if it was unintentional and you correct the problems. You pay your tax, pay your interest, come clean and the government will not revoke the election. Then the buyer is buying a clean company as far as taxes are concerned,” he says.
LLCs really have no tax requirements. Anybody can own an LLC for tax purposes. They can do unequal distributions, can change distributions every year and it does not jeopardize the status.
In LLCs buyers can buy the interest, there are elections you make where if you don’t buy all of it, it still gives you a step up. Or, if you buy all of it, you treat it as buying assets.
Erin Duffy, partner in Duane Morris explains that the structure of the business is important when considering taxes, especially when it comes to LLCs. Duffy explains that LLCs can elect to be taxed as a corporation or partnership, whereas a similar structure, the LLP is just a partnership issue.
Duffy says that corporations in LLPs end up paying two types of tax: capital stock and corporate net income tax. She says within an LLC, owners would only pay the capital stock resulting in less tax imposed on an LLC versus a corporation. Duffy also adds that tax rates themselves are different between corporations and LLCs.
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.