How tax allocations and important goals and attributes play key roles in goodwill allocations.
By Bruce Bryen, CPA, CVA
As almost every dentist knows and understands, the goodwill of the dental practice is probably the most important and valuable asset held by the dental practice or the dentist.
Goodwill and Dental Practice Valuations / Shutterstock
Dental equipment is depreciated very quickly from a marketability standpoint similar to the way a car loses its value once it is out of the showroom. Small tools and other inventory and supplies are not worth much of the percentage of the worth of the value of the dental practice. The supplies and inventory are consistently being replaced as more patients come to the dental practice. The small tools wear out frequently and there must be items that are substituted for them.
The one constant in a dental practice that emits value is the goodwill of that dental practice. As the dental practice creates more revenue, the dental practice goodwill value increases dramatically, especially as the expenses are controlled and the net profit rises. This is such an important factor in determining the value of the dental practice that the goodwill is actually characterized with 2 different approaches.
One type of goodwill is considered to be that of the owner and is commonly named, “personal goodwill.” The second type of goodwill is known as the goodwill of the dental practice itself, more commonly called, “enterprise goodwill.” Each of these allocations has strong support for naming the goodwill either one or the other. Each characterization of the goodwill has huge ramifications regarding income tax considerations, the allocation on the settlement sheet of the practice sale items being sold and other important points to be discussed in this article.
Examples of personal goodwill and the dental practice goodwill commonly known as enterprise goodwill
An example of personal goodwill could be the name of the dental practice if that name involved the name of the owner. If the owner of the dental practice is hypothetically, John Smith, and the name of the dental practice was John Smith Dental, that would be a strong indication that the name of the dental practice was more likely a personal goodwill item, compared to an enterprise goodwill item. If the name of the dental practice was Ardmore Avenue Dentistry, and the owner was John Smith, the dental practice name would more likely be an enterprise goodwill item since the owner’s name was not mentioned as part of the name of the dental practice.
Another example could be if the production of revenue was created almost at 100% by John Smith, owner, that would be more likely to be allocated as a personal goodwill item, rather than an enterprise goodwill asset. This is extremely important when the income tax allocation of those assets being sold from the dental practice are listed. Any item that is considered as a personal goodwill item would receive capital gains treatment on the tax returns of the owner. This would apportion the lowest income tax rate available to the owner of the dental practice and would save the owner upon the sale, thousands and thousands of dollars now compared to any type of deferral of income tax plan for tax reduction. Other items of sale such as the quickly depreciated equipment would be subject to what is known as recaptured depreciation and would have ordinary income tax consequences. Of course, the organizational structure of the dental practice could aid or detract from the overall tax considerations paid or saved upon the sale of the dental practice. Each case is different.
Some other considerations when determining the allocation of the assets of the dental practice that are being sold
Personal goodwill cannot be transferred easily. It is therefore important to determine if as much of the asset allocation of the dental practice sale can be listed as personal goodwill as possible. Since a non-compete and non-solicitation agreement will allow the personal goodwill to be allocated upon the sale of the dental practice assets and the goodwill of the dental practice as well, it is important that the buyer and seller agree to allocate as much as possible to the personal goodwill assets. This will greatly assist the buyer of the dental practice. He or she will probably have to compromise on some other item to create a sense of fairness to the seller.
It is a rare occasion when a buyer will agree to a dental practice transition without the owner of the dental practice signing off on as many items as possible that would be known as personal goodwill items. The lawyers and the dental practice CPAs will argue about the allocation and should agree somewhere in the middle of the extreme amounts on each end of the value spectrum for the personal goodwill allocation. For the buyer of the dental practice, the personal goodwill amount may still be written off over a 15-year period. He or she will not lose the writeoff for income tax purposes but will have to take that writeoff over a longer period of time.
If the buyer and the seller of the dental practice are cooperative regarding the allocation of the sale price, is there something that the buyer receives that may be of benefit to him or her?
Since the writeoff of the goodwill must be allocated by the buyer of the dental practice over a 15-year period, he or she would have created a large asset on the books of the dental practice that will assist when that person sells the dental practice. That’s because his or her cost will be on the dental practice balance sheet. It will reduce the income tax that is owed upon the sale of the dental practice when that occurs. The balance left on his or her books of the personal goodwill will be a direct charge against the sale price that is ultimately received.
Editor’s 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].
