To be a great CEO of your optometry practice it is imperative that you have the right individuals on your team.  The best leaders of optometry practices are surrounding themselves with people who collectively make everyone better.  The examples and education below comes from J.R. Armstrong, a CPA at May & Company, LLP, in Mississippi, who works with optometrists throughout the United States in the transitioning of their practices.

ASSET PURCHASE: Tax advantage buyer

• The purchaser has the ability to depreciate the assets purchased, including the ability to take $179 on qualified assets. This is a huge immediate tax advantage to the purchaser.
• Depending on the breakdown of the sales price, the seller may have to report ordinary income on any gain on the sale of assets subject to a maximum federal rate in excess of 40%. Sales price allocated to goodwill/patient list is taxed as capital gain to the seller, while amounts allocated to equipment are ordinary income.

STOCK PURCHASE: Tax advantage seller

• The purchaser does not have the ability to deduct the purchase price. It becomes his stock basis in the practice, similar to if he were to purchase GM stock and later sell it; the stock basis would be used to calculate gain or loss on the sale at that point. There is no immediate benefit and no benefit until the eventual sale of the practice.
• The seller receives capital gain treatment on the entire gain on the sale of his practice, the federal tax rate is generally 15% – 20%

Example:

• Let’s assume Seller agrees to sell Practice for $250,000.
• He has drawn nearly all the profits out of the company each year leaving Seller with a $10,000 stock basis in the company
• He has taken accelerated depreciation on nearly all his equipment and has a tax basis of $15,000 in his equipment
• Seller is in the 33% federal tax bracket, for a married couple that equates to income of approximately $225,000 – $400,000

Asset Purchase:

• Seller and Purchaser agree to an allocation of $100,000 to goodwill and $150,000 to equipment
• Seller recognizes $100,000 of capital gain on the sale of goodwill and $135,000 of ordinary income on the sale of equipment
• Seller pays tax of $15,000 on the sale of goodwill and $44,550 on the sale of equipment for a total of $59,550
• Purchaser gets to deduct $36,666.67 in depreciation and amortization on his return, resulting in a tax benefit of roughly $12,000 assuming he too is in the 33% bracket.

Stock Purchase:

• Seller recognizes $240,000 of capital gain on the sale of his practice stock
• Seller pays tax of $36,000 on this gain
• Purchaser has a basis in the corporate stock of $250,000
• Purchaser gets no tax benefit until he sells the practice

Difference:

• In the asset purchase scenario, Seller pays $23,550 more in taxes than in the stock purchase scenario
• In the asset purchase scenario, Purchaser gets a tax benefit of $12,000 each year for 5 years (the depreciable life of OD equipment) and $2,200 for the following 10 years (the amortizable life of goodwill is 15 years)
• Over the entire 15-year life of goodwill and equipment cost recovery Purchaser gets a tax benefit of approximately $82,000 in an asset purchase situation.
• When Purchaser eventually sells the practice, he has already recovered the his basis in the practice through depreciation, so he will now be faced with a gain on the sale.

There are many other non-tax items that must be considered with respect to this decision, but hopefully this indicates the major cash-flow differences with respect to each method of purchase. Additionally, the actual results of the taxes will differ depending on both Purchaser and Sellers personal situation; i.e. amount of itemized deductions, other income, spouse salary, children etc.

Also, definitely something to consider – when you purchase the stock of a company, you also purchase any “skeletons in the closet” i.e. potential employment liability claims, unknown tax issues, potential patient litigation. There are insurance policies to cover these claims, but it’s certainly worth keeping in the back of your mind.

J.R. Armstrong is a CPA at May & Company, LLP.  He specializes in optometry practice accounting and is recommended by OptometryCEO.  He can be contacted through jarmstrong@maycpa.com.