Tax Implications of Goodwill When Buying or Selling a Medical Practice

Understanding the tax treatment of goodwill in the medical industry

Goodwill often plays a significant role in the sale and acquisition of medical practices. Whether you are a buyer or a seller, understanding the tax implications associated with goodwill is crucial. This article delves into the tax treatment of goodwill in transactions structured as asset sales from both perspectives, explores the concept of personal goodwill, and explains depreciation recapture when acquired goodwill is sold.

Goodwill: An overview

Goodwill represents the intangible value of a business above the value of its tangible assets. In the context of medical practices, goodwill can include factors such as patient relationships, brand reputation, and the practice’s future earning potential.

Tax treatment of goodwill for medical practice sellers

When selling the assets of a medical practice, the purchase price must be allocated among the tangible and intangible assets being transferred. Goodwill generally represents a large component of this allocation which is beneficial to sellers as the sale of goodwill is generally treated as a capital gain – see the depreciation recapture rules below for exceptions. This can be advantageous for sellers, as capital gains rates are typically more favorable compared to ordinary income tax rates.

Tax treatment of goodwill for medical practice buyers

Buyers also need to understand the tax implications of acquiring goodwill. Purchased goodwill is generally considered a Section 197 intangible asset which is amortized over 15 years. This means the buyer can deduct the consideration allocated to goodwill over 15 years, reducing taxable income and providing a significant tax benefit.

Personal goodwill

Personal goodwill refers to the value directly attributable to the personal skills, reputation, and relationships of the individual practitioner rather than the practice itself. This distinction can have significant tax implications.

1. For sellers: An allocation of sales price to personal goodwill can be particularly advantageous when the medical practice is structured as a C corporation as it can reduce double-taxation inherent in that structure. For example, the gain associated with the sale of goodwill owned by a C corporation is taxed once at the corporate level and a second time as a capital gain at the individual shareholder level when the proceeds are distributed. If the same transaction was structured in a way that personal goodwill, instead of corporate goodwill, was acquired, then the gain would be subject to capital gains tax at the personal shareholder level only.  It is critical that the existence of personal goodwill be documented in these types of transactions. This requires careful review of employment and/or non-compete agreements as well as other facts and circumstances.
2. For buyers: The treatment of personal goodwill for the buyer is similar to regular goodwill, in that it can be amortized over 15 years if acquired. However, establishing personal goodwill separately may complicate the allocation process.

Depreciation recapture

Depreciation recapture can occur when goodwill that was previously acquired in a taxable transaction is later sold. This causes a portion of the gain on sale of goodwill, which is generally considered a capital gain, to be recharacterized to ordinary income. Sellers and their advisors should be aware of the existence of depreciation recapture in transactions involving acquired goodwill as it can have adverse tax consequences.

Conclusion

The tax treatment of goodwill in the medical industry involves several critical considerations for both buyers and sellers. Understanding how to allocate, amortize, and report goodwill, as well as recognizing the implications of personal goodwill and depreciation recapture, is vital for optimizing tax outcomes.

Whether you are buying or selling a medical practice, consulting with a seasoned tax professional can help navigate the complexities and ensure compliance with IRS regulations. Proper planning and strategic allocation can make a significant difference in your overall tax liability, providing potential savings and maximizing the value of your transaction.

Questions? Keiter’s Healthcare & Medical Practices team can help you if you’re considering a transaction. Contact us. Email or Call: 804.747.0000

Sources

• 2024 Thomson Reuters/Tax & Accounting | Disposing of Section 197 Assets Disposition Subject to Recapture
• 2024 Thomson Reuters/Tax & Accounting | I-8602. Goodwill on sale of professional practice or personal service business.