The author, a certified public accountant with over 45 years of experience, explains the role a tax expert can have when it comes to saving money while purchasing a practice.
By Bruce Bryen, CPA, CVA
Those dentists who are ready to purchase a dental practice for the first time or those who have had prior acquisitions know the value of expert advice regarding the tax aspect of their purchase. The difference between a tax-oriented purchase and an acquisition with few or no tax considerations may end up costing the acquiring dentist hundreds of thousands of dollars, sometimes during the acquisition process.
This type of problem occurs when the loan payments begin appearing with large amounts attributed to the outstanding balance. What is especially difficult for the dentist to understand is that every time the loan is being amortized, that amount of amortization is subject to tax. Examples include a dentist in the 50% federal and state tax bracket who wants to pay off his or her acquisition loan as quickly as possible. Let’s look at the loan payment and see what it means with a few examples.
Loan payments and the potential federal and state taxes attributable to those loan payments
Using an example of a $1,000,000 loan that was used to secure the acquisition of a dental practice based on a 5-year term loan at $200,000 per annum the following occurs: The loan payment reflects a potential federal and state income tax of almost $200,000 each year. The explanation is as follows: How does a dentist earn enough to pay $200,000 on the loan balance? He or she must earn almost $400,000 since there will be a potential tax of $200,000. That leaves the $200,000 needed for the amortization of the loan.
The goal of the advisor is to develop methodologies to attempt to reduce the amount that is subject to tax because those sums are treated as income that is taxable. There are methods that can be used to reduce the taxable income of the dentist. The best advice that a dental practice financial advisor can use as an approach to reduce the taxable income of the discussion dental practice is to offer something that is part of the dental practice. This is compared to investing in a shopping center development, movie or some investment strategy that is outside the scope of the control of the dentist and his or her dental practice. One of the most successful approaches for the dentist who is acquiring a dental practice at about the lowest tax cost possible is to use the concept of the retirement account to “write off,” the purchase price of the dental practice and to pay little or no tax on the transaction. More detail will follow in the next article about how this is legally possible for the dentist. Essentially this concept allows the acquiring dentist to save almost $1,000,000 in federal and state tax on the acquisition of a dental practice with a price tag of $1,000,000.
What can a dentist and his or her advisor use as an investment vehicle or as an approach to procuring a tax write-off but still controlling the funds that are being used from the dental practice?
Probably the safest and most reasonable approach that a dentist can make is for the dental practice to elect the adoption and operation of an employer sponsored qualified retirement plan. This type of retirement plan is qualified by the Internal Revenue Service as being acceptable to it and tax write-offs are allowed for the funds that the dental practice contributes to it as long as the rules of the plan are followed.
The income earned by the plan is not taxable until it is distributed to the participants who then pay the tax on it. Formulas for the amount of the annual contribution are written into the plan to determine what amount of contribution is made by the dental practice to the retirement plan. Allowable investments are listed in general categories so that almost all stocks, bonds and other types of marketable trading instruments are acceptable.
There are formulas that are included in the retirement plan that express the amount of distribution that each participant shall receive each year based on a vesting schedule that is reflected within the retirement plan as well. In many cases, the dentist may be the trustee of the plan and direct the investments of the plan. As long as the trustee does not take the funds to eliminate the participants from receiving their allotted share, things should go smoothly. An actuary is needed for the design of the employer sponsored qualified retirement plan. The dental CPA should be familiar with the type of plan being discussed here. This type of plan is called a defined benefit plan. One of the redeeming factors of this type of tax deferral is that the funds for whatever the investments may be, stay under the control of the dentist if he or she desires to be a trustee. The dentist can be a co-trustee if he or she wants to employ a professional money manager for advice and for holding the funds as well.
Think of the investment opportunities where the dentist or the dental practice has the right to control the funds?
Those amounts remain available for anything except self-dealing between the dentist, the dental practice and anyone related to these parties. The rule that governs where the money is invested is for the protection of the dentist, the dental practice and those individuals who are participants within the retirement plan.
Investments that are in the general business marketplace do not have the ability for the dentist to have the control of those funds. As previously discussed, real estate investments, yachts, airplanes and their leases and those types of investment opportunities normally involve the personal guarantee of the dentist on amounts of debt that are large enough to create a tax-sheltered advantage for the dentist. This also comes with the potential for future added value to those items. The drawback is the enormous risk to the dentist on a personal level which many times includes the guarantee of the spouse of the dentist as well. It is difficult for the dentist to find an opportunity where the control of the funds stays with the dentist.
Editors Note: Bruce Bryen is a certified public accountant with over 45 years of experience and is a part of Baratz & Associates CPAs. He is a regular contributor to Dentistry Today and more articles on finance and practice acquisitions can be found at dentistrytoday.com. Bryen specializes in deferred compensation, such as retirement planning design; income and estate tax planning; determination of the proper organizational business structure; asset protection and structuring loan packages for presentation to financial institutions. He is experienced in providing litigation support services to dentists with Valuation and Expert Witness testimony in matrimonial and partnership dispute cases. You may contact him at [email protected].
