The Tax Consequences in an Asset Versus Entity Sale
A major consideration when choosing how you will organize your sale is to know something about the tax consequences of each kind of sale. We generally talk about Asset Sales versus Entity Sales, and we've written a bunch about the differences between the two in other posts. (See this one if you don't know the difference.)
Assuming you do know the difference, let's jump in and let’s keep it simple…
Most of us know that ordinary income tax rates can vary and go north of 35% depending upon your individual tax situation. The long-term capital gains rate tends to hover around 15%.
Long-term capital gains are taxed at more favorable rates than ordinary income. The current long-term capital gains tax rates are 0%, 15%, and 20%, while the rates for ordinary income range from 10% to 39.6%.
Most of us of course would prefer to be taxed at as low a rate as possible, and most entity sales will be taxed at the long-term capital gains rate.
Taxation in Asset Sales
Most entity sales will be taxed at the long-term capital gains rate.
In contrast, in an asset sale, at least some of the assets will be taxed at ordinary income tax rates. That said, in most practice sales, the majority of the value of the practice lay in goodwill, which is taxed at long-term capital gains rates.
In the first example, an entity sale, the stock of the company is trading hands, and the gain is like a long-term stock gain for the sellers (long-term capital gains rate).
In an asset sale of a medical practice, let’s say you, the seller, have made a list of all the furniture and fixtures that are part of the sale. You bought that couch in the waiting room for $1,000, depreciated it over the last five years on your tax returns, and then valued it at $200 on your list of assets when you sold the practice. The difference between the value of the fully depreciated asset ($0) and the sale price ($200) is taxable at ordinary income tax rates. Multiply that out over all your fixed assets, and you can see where this can lead.
It should be noted that goodwill and other intangibles such as intellectual property may be taxed differently (in fact, more favorably) for a buyer.
For this reason, during negotiations, a seller will want to minimize the value of tangible assets and amplify the goodwill, while the buyer will seek to do the opposite. (Check out this link for more on the details of goodwill in a medical practice.)
Asset Sales: Allocating Assets for Tax Purposes
As inferred above, for tax purposes, asset sales can be broken down into different asset classes such as goodwill, tangible assets, intangibles like intellectual property, non-competition agreements and the like. The way that the total purchase price is allocated among these categories, each of which is taxed differently by the IRS, can be a major point of negotiation between a buyer and seller.
A sample asset allocation schedule in an asset purchase agreement.
Once both parties have agreed and the sales contract is signed, a section in the agreement will need to spell out the allocations. Both the buyer's and the seller's accountants will then look at the allocations agreed to in order to file Form 8594, the Asset Allocation Statement. The IRS will expect the allocations to appear the same on the buyer's and the seller's tax returns!
For more on how different kinds of asset classes are taxed, of course you will need the help of a CPA. We also highly recommend you check out this whitepaper from Raymond James.
A Quick Comparison
Asset Sale
-Sell all assets of a medical practice.
-Only choice for sole proprietors.
-Can be done as an individual or as a corporate entity.
-Liability for assets only.
-May be easier to deal with for smaller businesses tax-wise.
-Overall, may be more advantageous for both parties, as they can negotiate the value of each asset class with one another for tax purposes.
Entity Sale
-Sale of entire corporate entity (S- or C-Corp, LLC, etc.).
-Can only be done entity-to-entity, no sole proprietors.
-Liabilities carry over to new owner unless exceptions are made.
-May be more advantageous for seller liability-wise. Less so for a buyer, who may be taking on the liabilities (risks) of the corporate entity they are purchasing.
So Which Should I Do? An Entity or Asset Sale?
The key is in how you frame it.
While one corporation can sell its assets to another, if the seller is organized as a C-corp, doing an asset sale exposes the shareholders to the specter of double-taxation. Whereas, if the entity is sold in its entirety, the sale of the stock of the corporation results in only one tax bill. And In an entity sale, even if the buyer is able to have some exceptions made in the sales contract to accepting certain liabilities, they are accepting all others.
In an asset sale, it’s kind of the opposite: a buyer can pick and choose which assets they want and which they don’t, likely cherry-picking the most valuable assets and leaving the others behind. They will probably have zero liabilities related to the assets they acquire, and will receive a more favorable tax treatment from an asset sale, getting write off big parts of the sale once it’s over.
Given the points covered above, the bottom line is that a corporate entity with no liabilities will most likely want to sell the whole entity, while an asset sale may be more advantageous for both parties, as they can negotiate the value of each asset class with one another for tax purposes. This is why we usually recommend most clinics do an asset sale.
And if the seller is a sole proprietor, there’s no choice: it will be an asset sale.
The Mandatory Disclaimer
It is important that you consult a CPA before making a final decision on how you transfer the business. The advice we give here is based on our knowledge and experience, but we’re not CPAs, and we want you to know that.
Contact Us Now
If you’re still wrestling with what kind of sale would be best for your individual situation, we’d be happy to discuss the pros and cons with you. Reach out to us below. The first call is free.
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