What Uncle Sam gets when you sell your practice
James C. Cofer
James C. Cofer is a partner in the tax group at the law firm Seward and Kissel LLP in New York City and Washington DC.
If youre thinking of selling your veterinary hospital, focusing just on the sale price is not enough. You need to understand the tax consequences of a proposed sale.
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With hospital groups and corporate chains buying more hospitals than ever before, right now could be the right time to sell your veterinary clinic. But if you're thinking about selling, focusing on just price is not enough. You need to understand the tax consequences of a proposed sale. Regardless of how much a buyer ultimately pays, any taxes owed to the government will ultimately reduce the owner's net proceeds from a sale.
Here are some factors to consider about potential tax issues involved in the sale of a veterinary hospital.
How is your veterinary clinic organized?
The tax consequences of a sale will depend on how the hospital is taxed for federal income tax purposes. The entity in which you conduct your practice is taxed either as a partnership or sole proprietorship, an S corporation or a C corporation, respectively, for federal income tax purposes. Certain states require veterinary practices to be conducted in corporate form. In those states, the use of a partnership may not be possible.
Partnership. If your practice is conducted in a partnership (or a sole proprietorship) for federal income tax purposes, the entity in which you conduct your practice is not subject to U.S. federal income tax. Instead, you pay taxes annually on your share of the income of your practice. A partnership is advantageous because it's a very flexible structure. However, you can't be both an employee and a partner of a partnership, which means there are certain benefits provided to employees not available to you as an owner.
S corporation. If your practice is conducted in an S corporation for federal income tax purposes, the S corporation is also not subject to federal income tax. As with a partnership, you pay taxes annually on your share of the income of the practice. However, an S corporation is not as flexible as a partnership. An S corporation can have only one class of stock and can only have U.S. individuals (and certain trusts) as shareholders. In addition, unlike a partnership, assets cannot be distributed from an S corporation to its owners in a tax-free manner. An S corporation is advantageous because you can be both an employee and an owner of an S corporation, and the distributions you receive in excess of your reasonable salary are exempt from self-employment tax.
C corporation. If your practice is conducted in a C corporation for federal income tax purposes, the C corporation is subject to federal income tax on its net income and you are subject to taxes on any dividends or salary you receive from the C corporation. Given the recent reduction in federal income tax rates, this is not as big a tax burden as it once was. However, most states impose taxes on C corporations, but not on S corporations or partnerships. Unlike an S corporation, a C corporation can have any number and types of shareholders and classes of stock. But like an S corporation, assets cannot be distributed from a C corporation in a tax-free manner.
How are you selling your veterinary clinic?
Your tax consequences may vary depending on whether you are selling assets or equity to the new owner. This can determine whether some or all of your gains on the sale are taxable as ordinary income (maximum 37% tax rate) or long-term capital gains (maximum 20% tax rate).
For a partnership, a sale of the assets and a sale of interests in the partnership are generally treated the same. Most of the gain that you derive from the sale of your practice will be long-term capital gain, except for certain small amounts taxed as ordinary income.
For an S corporation, a sale of assets is treated in the same manner as for a partnership (mostly as long-term capital gain). A sale of shares of an S corporation is also treated entirely as long-term capital gain (as long as those shares have been held for more than one year). However, a buyer will generally not want to acquire shares of an S corporation (unless the buyer is a C corporation), because the buyer will not be able to amortize (or recover the cost of) the purchase price.
For a C corporation, a sale of assets is taxable to the corporation at a rate of 21%, and the subsequent distribution to the shareholders is taxable at a rate of 20% for a total tax liability of roughly 37%. Although a sale of shares of a C corporation is treated entirely as long-term capital gain (as long as those shares have been held for more than one year), a buyer will generally not want to acquire shares of a C corporation (unless the buyer is a C corporation), because the buyer will not be able to amortize (or recover the cost of) the purchase price.
What about rollover equity?
Rollover equity means that rather than receiving just cash from the sale of your practice, you receive a portion of the purchase price in equity of the buyer (i.e. you “roll over” a portion of the equity of your business into equity of the buyer's business).
From a tax perspective, it may be possible for you to receive this rollover equity on a tax-deferred basis. This means you aren't taxed on the rollover equity until you dispose of it. And when you sell the rollover equity, your gain will generally be taxed as long-term capital gains. Whether rollover equity can be received in a tax-advantageous manner depends on how the buyer's business is structured.
If your business is organized as an S corporation or a C corporation, the tax-deferred status of the rollover equity can only be maintained for as long as the S corporation or C corporation continues to hold the rollover equity.
The above only covers the federal income tax consequences of a veterinary hospital sale. State tax consequences may vary and should also be considered as part of any sale. You can see that taxes can play a big part in how to structure a business and how to sell it. I recommend that a tax advisor experienced in mergers and acquisitions be consulted early on in any sales process. A well-informed practice owner will be better equipped to achieve his or her desired financial result from any proposed sale.
Editor's note: The author asked us to include the following disclaimer: “The information contained in this article is for informational purposes only and is not intended and should not be considered to be legal advice on any subject matter. As such, recipients of this article should not act or refrain from acting on the basis of any content included in this article without seeking appropriate legal or other professional advice. A recipient of this article shall not be treated as a client of Seward & Kissel LLP by virtue of its receipt or readership of this article.”
James C. Cofer is partner in the tax group at the law firm Seward and Kissel LLP in New York City and Washington DC.