At its most basic, your gross sales proceeds (pre-taxes) will be reduced by your tax bill (which usually falls between 20 to 35 percent of the cash received). This wide percentage range depends on the state you live in and the advice you receive. Taxes are a part of life and support our government which has presided over the strongest economic system in the world. When you undergo a major event like a business sale, knowing how much you will owe the government is critical to understanding the proceeds available to you for retirement.
The legal structure of your business matters in determining your tax bill. This piece is written assuming that your hospital was set up as either an S-Corporation or an LLC. If your practice is established as a C-Corporation, a myriad of tax issues will affect your sale that your accountant and other advisors need to work through.
Ordinary Income vs. Capital Gains
Capital gains taxes are currently materially lower than the tax on wages or income. A long-term capital gain is earned when you own an asset for over one year, and it is sold, where the calculation figures the gain over your original investment when you sell the asset. For example, if you bought your veterinary practice in 2001 and sell it in 2023, you have owned the asset for over a year – so most of the ‘gain’ will be a long-term capital gain. The amount that you paid for the practice is your ‘basis’ or the original investment. The basis amount can decline over time depending on how your accountant has handled your taxes over the years. Note: if you paid a substantial amount to buy the practice, this basis would reduce your ultimate tax bill because the ‘gain’ you pay taxes on is close to the amount above your original purchase price.
Long-term capital gains are beneficial in that it’s taxed at a maximum rate of 20 percent by the federal government. This is much less than the maximum rate on ordinary income (37 percent). If you can claim capital gains (most practices should), you will save big on your tax bill.
Certain pieces of the veterinary practice sale are treated as ordinary income. They are:
- Non-competition agreements: any value allocated to non-competes is treated as ordinary income because of the personal nature of this asset. It’s important to ensure you negotiate a low dollar allocation to your non-compete provision.
- Depreciation recapture: this is a complex concept related to the value of the fixed assets of your practice. Usually, it’s a small percentage of the total purchase price, with the key being to minimize the allocation of dollars to your fixed assets.
In addition to the federal tax rate of 20 percent on capital gains, there is an additional tax on capital gains. Instituted with the Affordable Care Act, there can be another 3.8 percent on certain capital gains. This Net Investment Tax or ‘Obamacare surcharge’ on the capital gains is one that you and your advisors need to determine if it applies to the sale of your practice.
The major variation in the tax bill depends on the state where your practice is located. If you own your practice in Florida, Texas, or Nevada, states which have no state income taxes, your bill is generally equal to your federal tax obligation.
On the other hand, a state like California has a more than 13 percent maximum state tax rate, plus additional taxes that can require you to pay over 35 percent of your proceeds to the federal and state government. In high-tax states, there are several mechanisms to attempt to mitigate or reduce your taxes, but these strategies require a deep understanding of transactions and the taxes associated with them.
What is Taxed at Closing?
In most transactions, when you receive your cash is when you are generating taxable proceeds. Transactions today include many features, such as TopCo equity in the buyer, joint venture interests in your hospital, contingent notes, and earnouts.
The basic rule of thumb: when you receive the money, that’s when you owe taxes. For example:
- If you receive 15 percent of the purchase price in TopCo shares (or units) of the buyer, then you do not pay taxes on that piece until the buyer does a recapitalization or sale (and you receive cash for those shares).
- If you retain a 20 percent ownership stake in your hospital, you are only taxed on the cash you receive for the portion of the business sold. In the future, when you sell the 20 percent retained ownership stake, you will be taxed at that time.
One way to allow your assets to grow on a pre-tax basis is to defer some of the purchase prices through TopCo shares or through a joint venture interest in your veterinary hospital.
There are complex tax deferral strategies that allow you to postpone most of the taxes due on the cash proceeds you receive today by placing the cash into trusts or other investment vehicles. You can read an outline of these approaches by visiting our article on [insert topic].
Some accountants and attorneys have minimal experience helping business owners sell their practices and fail to think through all the appropriate tax minimization strategies as a result. Choosing advisors that have deep transaction experience will set you up to retain as much of your sales proceeds as possible.
Once your Letter of Intent (LOI) is signed with a potential buyer, we recommend asking your tax accountant to provide an estimated tax bill for the transaction. That way, you’ll have a basic understanding of how much money will go into your pocket after the sale. Getting this estimate early in the process and sharing it with your attorney and broker will allow all your advisors to weigh in on tax minimization strategies.
At Ackerman Group, we have brokered over 200 transactions, worked with different types of accountants and attorneys, and navigated every possible scenario in the veterinary acquisitions space. We have a reliable network of quality advisors we can connect you to so that you can retain the largest possible piece of your transaction proceeds.