By Michael A. Igel, Esq., and Cameron Pariseau, Esq

This is the first in a series of articles about key legal issues involved in buying or selling medical practices. The article is for informational purposes and should not be taken as a substitute for advice from personal legal counsel.

The purchase and sale of any business can be a daunting task. A transaction involving a medical practice is even further complicated by confusing and often impractical laws and regulations.

While focused on business and contractual terms in the highly-regulated health care industry, buyers and sellers often ignore important tax implications of practice sales. When not properly handled, these oversights create a significant financial impact on practice buyers and sellers. Parties have competing interests when it comes to allocations, so understanding these particulars is essential. This article is the first in a series designed to educate physicians on the issues associated with the sale or purchase of a health care business.

Types of transactions

The two most common types of practice sale transactions are stock sales and asset sales. The appropriate structure for a particular transaction depends on a number of fact-specific criteria. The focus of this article is related tax considerations for the buyer and seller.

Stock sale: In a stock sale, a practice's assets and liabilities remain in the entity and continue to be carried in the same manner as before the transaction. Sellers generally prefer a stock sale because it allows them to completely step away and avoid responsibility for any past and future liabilities relating to the practice -- although purchase agreements are often structured to shift liability responsibilities back to the seller for the practice's operation during the period prior to closing. Buyers tend to disfavor stock sales because of the increased risk of assuming a seller's liabilities. However, some practice buyers prefer stock sales because assuming third-party payer contracts and Medicare numbers is often easier.

Asset sale: In contrast to a stock purchase, in an asset sale the buyer and the seller choose the assets and liabilities of the practice to be sold or transferred to the buyer, while the selling entity remains in existence for a period of time following deal closing. The buyer typically purchases substantially all of the seller's assets such as equipment, patient lists, goodwill and other items. An asset purchase also allows the buyer to better pick and choose those assets that it wishes to purchase (e.g., a particular piece of equipment) while excluding those liabilities it does not wish to assume (e.g., unfavorable contracts or pending litigation).

Allocation of purchase price

One of the first provisions that buyers and sellers see in a practice sale agreement covers the allocation of purchase price. The IRS requires parties to a transaction to allocate purchase price among certain "classes" of assets. Classes of assets include the following: • Value of stock, if the transaction is a stock sale

• Value of tangible assets (e.g. fixture and equipment), if the transaction is an asset sale
• Value of intangible assets (such as goodwill)
• Value of non-compete

IRS regulations state that if the buyer and seller of a business agree on the allocation of the purchase price, the IRS will respect the agreed upon allocation unless it is "not appropriate."

S-corporations and C-corporations

Di?erences in the income tax treatment of C-corporations and S-corporations should be considered at the onset of structuring a transaction. Since a C-corporation pays tax on its earnings, and its shareholders are taxed again when dividends are paid to shareholders, C-corporations are subject to double taxation when assets are sold. On the other hand, a sale of the stock of an S-Corporation will typically result in taxation only to the individual shareholder(s), and usually at the lower capital gains rate.

S-corporations (in addition to partnerships and LLCs), however, are not taxed at the entity level. Rather, they are taxed only to the individual owner(s). Th at is, the income is taxed only to the corporation's shareholders. Th us, as will be discussed more fully in a future article, it is important to structure a practice sale in a manner that is sensitive to the tax "class" of the selling entity.

Tax impact

From the buyer's perspective: Asset sales typically benefit buyers from a tax perspective. By allocating higher values for assets that depreciate quickly (such as equipment) and lower values for assets that depreciate slowly or not at all (such as goodwill), a buyer can reap tax benefits from the purchase price because depreciable assets can be written o? in future fiscal years. Purchased equipment can often be deducted (up to a certain dollar amount) under Section 179 of the Internal Revenue Code, resulting in an immediate tax savings. To the extent equipment does not qualify under Section 179, it can still be depreciated over a period of only seven years or fewer, depending on the type of asset. Goodwill and the non-compete, on the other hand, must be amortized over 15 years. Thus, it is in the buyer's best interest to maximize the purchase price allocated to tangible practice assets, and to minimize the amount allocated to goodwill.

Of course, the value of tangible assets must be based upon fair market value in order to meet IRS and health care regulatory requirements.

From the seller's perspective: While buyers typically prefer an asset sale, stock sales typically benefit sellers. In a stock sale, a selling physician owner recognizes a taxable gain or loss based on the di?erence between the purchase price and the owner's tax basis in the stock, where any gain is taxed at the more favorable capital gains rate.

In an asset sale, a selling physician practice recognizes a taxable gain or loss based on the di?erence between the allocated sale price and the tax basis of the assets and liabilities. As noted above, if the selling practice is a C-corporation, an asset sale typically results in an increased, "double" tax burden.

By the time practice's assets are sold, much of the practice's equipment has likely been fully depreciated for tax purposes.

Therefore, any amount allocated to equipment that exceeds the book value of that equipment will be taxed at an ordinary income rate. Special attention should be paid to the portion of the purchase price that is allocated to the non-compete, which is also taxed at an ordinary income rate. Goodwill, on the other hand, is taxed at the much lower capital gains rate.

While buyers typically favor asset purchases and sellers typically favor stock sales for tax and liability reasons, often a mutually agreeable structure can be reached through well-planned negotiations. Future articles in this series will discuss other topics to consider when negotiating the sale or purchase of a medical practice, including but not limited to:

• Health care compliance concerns
• Letters of intent (LOI)
• Non-competition and other restrictive covenants
• Representations and warranties
• Third-party contract consents, and post-closing issues.

Mike Igel, Esq., is Board Certified in Health Care Law and serves as a Co-Chair of the Health Care Team and Chair of the Health Care Defense Team at Johnson, Pope, Bokor, Ruppel & Burns, a law firm with offices in Tampa, St. Petersburg and Clearwater. His practice includes matters such as health care business transactions, health care regulatory and compliance guidance, physician-hospital joint ventures, mergers and acquisitions, and managed care contracts. Cameron Pariseau, Esq., is an associate in Johnson Pope's Health Care Team and Health Care Defense Team. She provides transactional and regulatory advice to health care and corporate clients, and she has experience with a broad range of business transactions including business formation, mergers and acquisitions.

Article reprinted from Florida Medical Magazine with permission from the Florida Medical Association.