Think Taxes When Selling or Buying a Center
The sale and acquisition of an urgent care business comes with many things. New patients, expanded brand name, new locations, etc. However, one thing that should also be considered is the tax implications that are involved with the many different areas of the acquisition on both ends of the sale. The Ambulatory M&A Advisor has gathered with financial and legal experts to help bring to light some of the tax issues that could be in the shadows of your sale.
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 earned by the corporation and then pay those taxes at their personal tax rates. That’s on the corporate side,” Grayson says.
Grayson says there are also Limited Liability Companies (LLC) which are very popular today. According to Grayson, in an LLC, you elect how you want to be taxed and most of those, they elect to be taxed as a partnership, which means there is no tax at the LLC level and the members are taxed as if they earned the company’s income on a pro-ratta basis.
“Basically, if you are a shareholder at a sub S-Corporate level, you will be taxed about the same as one who is a member in a LLC that is elected to be taxed in a partnership,” Grayson says.
When it comes to the actual assets acquired in a sale, there is no difference on how the assets for either a corporation or LLC are taxed, according to Grayson.
“When you sell a business, if it’s a sale of assets, then the corporation would pay taxes on the gain that it received from the sale of the assets. Then, when it distributed the proceeds, the shareholders are going to get taxed again. That would be capital gain, but then you have double taxation. In a sale by an LLC or sub S, then they are going to be taxed based upon their individual being. There isn’t double taxation in that situation,” he says.
When it comes to stock sale versus asset sales in an acquisition, tax-wise, as a general rule, a seller likes the sale of stock, more than they like the sale of assets because the transaction is so simple to close when you are selling stock or membership interest in an LLC, Grayson says.
“You simply sign over your interest. You sign over you shares of stock just like you would sell off a share of “Apple”. The buyer simply becomes the owner of that stock, and the company stays in existence and the buyer has taken over all operations of the company. The seller gets capital gains treatment on the sale of the stock, everybody is happy and they go home,” he says.
“If you sell assets, the company is selling the assets, but the company still retains the liabilities that arose prior to closing. The seller then really has to wind down the company. The buyer likes to buy assets because they don’t take the pre-closing liabilities of the seller; plus, they get a better tax treatment to depreciate the assets.”
Zandra O’Keefe, managing director, CBIZ explains that from the seller’s perspective there are special issues that you should consider planning up front for.
“ The sale of assets is a common transaction type. There is a misconception that in an asset sale deal, it’s pretty straightforward and there are no real tax implications. However if the seller owns technical component equipment subject to debt and the both the asset and debt transfer to the buyer, the debt relief acts as proceeds and can create taxable gain with no corresponding receipt of cash. Dry income results,” O’Keefe says.
She says that sellers should also be involved in the allocation of the purchase price during negotiations once it’s determined and it should be in writing as part of the executed agreement.
For the sale of a business, form 8594 is to be completed in mirror image by both the buyer and seller subject to a non–filing penalty. It’s in the seller’s best interest to allocate as much of the purchase price to goodwill as possible rather than to hard assets particularly if owned in an S-corporation or partnership entity structure. The sale of hard assets can result in higher ordinary tax rate gain, O’Keefe says.
” The sale of goodwill can be eligible for lower long-term capital gain rates and installment sale treatment. Unfortunately if the seller’s practice is a C-corporation, there would be no such opportunity. Or alternatively for certain types of medical practices, there could be an argument that there was no goodwill owned by the practice and it was all personal in nature held outside of the entity. Taking that position could reduce the overall tax bill it it’s not part of the valuation,” she says.
“Also the sale of “hot assets” held in a partnership practice such as the sale of accounts receivable can result in ordinary income, with no installment sale opportunity, even if no cash proceeds have been received in that tax year. Significant unexpected dry income could result and that means income without cash to follow closely behind it. If you want to sell the accounts receivable, then you’d negotiate up front that cash allocated to receivables be paid in full up front.”
O’Keefe also says that fringe benefits are sometimes an issue unless you plan, especially when you’re the one being acquired.
“As an employee now employed by the acquirer, you’ll want to negotiate up front and in writing that as many of your non-shared business expenses are reimbursed. Some examples are CME, marketing, automobile business mileage reimbursement, cell phone, computer, etc. As a W-2 employee, you may not receive benefit on your personal return due to adjusted gross income limitations when reporting these expenses on your 2106 form,” O’Keefe says.
Chip Wry, member, Morse Barnes-Brown Pendleton examines the area of deferred contingent payments and the tax issues that come with this aspect of a sale.
Wry says deferred contingent payments usually fall into a couple of categories. Sometimes the buyer will want to escrow a portion of the purchase price to make sure that the reps and warranties are true. According to Wry, those are basically promises and assurances about the business. If any of those promises get breached, the buyer wants to be able to look to the seller to indemnify the buyer for damages that arise from the breaches.
“Typically the buyer will want to put some portion of the purchase price into an escrow account for some period of time to make it be able to make itself whole for any indemnification types of claims that may happen. That is one situation where you typically see that there is payment at the closing of the sale, and then at some point thereafter, there is the release of whatever is left in this escrow account. If there aren’t any claims, if all the reps and warranties were true, then the escrow is released out to the seller at the end of the escrow period, and that is an additional amount of price that the seller gets,” Wry says.
The other kind of deferred payment is an earn out which is typically used to resolve a disagreement between the buyer and the seller about the value of the business that is being acquired.
Based on the actual tax aspect of the deferred payments, Wry says that usually deferred payments are treated as additional purchase price, depending on whether it was a stock sale, an asset sale.
“It’s just more payment for what has been acquired. When the amount becomes determined that is to be paid of the deferred payment. You discount the amount back to the closing date at the Applicable Federal Rate. There is a present value of the payment that becomes due determined as of the closing date. That present value is additional principal amount and the excess of the payment that becomes due over that present value is interest,” Wry says.
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