Goodwill hunting: Branding and tax implications

September 8, 2015

J. Haden Werhan, CPA/PFS, Naomi Cooper Hochman

When it comes to transition or retirement, dentists have several options. They can sell their practices, find associates or simply throw their hands up and reduce office hours and production until they end up closing shop.

Two experts offer advice designed to help you when it comes time to plan for transition or retirement.

When it comes to transition or retirement, dentists have several options.

They can sell their practices, find associates or simply throw their hands up and reduce office hours and production until they end up closing shop. One option dentists don’t have, however, is to cross their fingers and hope for the best. Ideally, a doctor should start planning for retirement a minimum of five to 10 years ahead to fully maximize the value of the practice he or she has spent so many years carefully building.

Planning for transition is a process, one full of many variables, but dentists nearing retirement age can take the guesswork out of the process by keeping the intersection of two important areas - branding and tax implications - top of mind.

What’s in a name?

Some dentists believe it’s best to leave the rebranding process up to their successor so the new dentist can do whatever he or she wants with the practice name after taking it over. While that may at first seem logical, it is actually an inherently flawed plan. In reality, taking the steps to rebrand the practice and develop a transferable asset, and an identity within the community that transcends the identity of the practice owner prior to retirement, will pay off in dividends upon retirement.

In fact, doctors within five or even 10 years of retirement should consider changing the name of the practice well in advance of a potential practice sale to prime the pipeline of potential buyers. After all, what is “Jess Jones DDS” really worth without Dr. Jones?

Dentists have the unique opportunity to forge long-lasting relationships with their patients, and much of the reputation of a practice is inextricably tied to the dentists themselves. It’s important to maximize the practice’s value when it’s time to sell, and having all of its brand equity wrapped up in the primary dentist’s name means one of the practice’s most important assets isn’t transferable.

Furthermore, it means any young dentist considering purchasing that practice knows he or she will have to take on a considerable up-front marketing burden in addition to the price of purchasing and financing the practice and any equipment/facility upgrades.

Imagine the fictional Dr. Pat Price, who is 30 years old and shopping around for a practice in Springfield. There are two practices up for sale in town with nearly identical locations, patient bases and facilities. Practice A is named Jess Jones DDS after the long-time dentist/owner. The practice’s website comes up on the first page of search engine results for dentists in the area, but the URL is drjonesdds.com and its signage and business cards all reflect the retiring doctor’s name. The practice’s Facebook page and other social media profiles, as well as all of its overwhelmingly positive online reviews, are also all listed under Dr. Jones’ name and worthless to young Dr. Price, as a result.

Dr. Price knows if he is to buy Dr. Jones’ practice, the cost of a new logo, internal and external signage, a new practice website and printed materials like business cards and letterhead alone will easily rise into the mid-five figures. Add to that the cost, including the time and energy, of rebranding the practice, building a new website and starting the practice’s social media and online review profiles from scratch and putting the necessary marketing infrastructure into place for this practice starts to feel like a part-time job the new dentist won’t have time for.

Practice B, on the other hand, was rebranded several years ago as, let’s say, Main Street Dental Care. Its website needs a simple update to the doctor’s photo and bio page to be perfectly good for Dr. Price’s immediate needs. The practice effectively has all of the necessary marketing assets already established in an easily transferable brand, and it’s easy to imagine how much more attractive Practice B appears to Dr. Price as a result.

Once a dentist has made the decision to rebrand in preparation for eventual transition, choosing the new practice name isn’t always simple. Many factors should influence the decision, including location, type of care offered, patient base and the practice’s unique selling proposition.

Along with a new name, a new branding scheme will need to be created, including professional logo design. Hiring a graphic designer to execute the rebranding process will ensure the new identity is contemporary, professional and visually impactful. Be diligent in choosing a trusted graphic design professional, ideally one with both branding and dental industry experience.

Once complete, be diligent in implementing the new branding across all online (website, social media profiles and patient review sites) and offline (letterhead, signage, business cards, patient forms and promotional materials) platforms to create consistency for the new direction of the practice.

Hot read: If you had $10,000 to spend, what would you spend it on in your dental practice? Part 2 of 2

Tax implications and myths

There are a variety of myths about tax implications, particularly when it comes to issues around the name of a dental practice.

Corporations vs. sole proprietorships

One common belief, for example, is that a dentist must have a corporation to use a fictitious name. This is not the case in California, but dentists should check with their own state dental boards about these rules.

Setting up a corporation simply for the purpose of using a fictitious name or DBA may actually create additional costs and compliance requirements the dentist may not want to bear. Many states impose a minimum tax or annual fee for the privilege of having the corporation. And a corporation’s books and records have to be kept separate and distinct from the owner (shareholder) because it is an entity all its own.

Part 1: What $10,000 could do for your practice

S corporations vs. C corporations

Dentists often hear the pros and cons of an S corporation versus a C corporation, and it can be hard to determine which is the better option. The reality is that a corporation is a corporation, but if an “S election” has been filed, the corporation is treated as a pass-through entity, meaning income, losses, deductions and credits pass through to the shareholders and are taxed only at the individual level. This saves double taxation or paying the flat 35 percent income tax for personal service corporations plus tax on income at the individual level upon receipt by the shareholder(s).

Corporate goodwill vs. personal goodwill

Goodwill is defined as an intangible, salable asset arising from the reputation of a business owner (dentist) and the relationship with his or her customers distinct from the value of its stock and other tangible assets.

Goodwill is an asset that, upon purchase, a buyer can write off (amortize) throughout 15 years. Upon its sale, goodwill is taxed as a capital gain as opposed to ordinary income-the difference in tax being almost half (20 percent for capital gains compared to up to 39.6 percent for ordinary income).

Goodwill can be purchased or self-created. This is important when it comes time to sell the practice. If Dr. Adams started her practice from scratch, all of her goodwill is self-created. Compare that to Dr. Barnes, who purchased her practice. Part of the original purchase price will have included goodwill. Why the distinction? Dr. Barnes deducted (amortized) her purchased goodwill throughout 15 years. Upon the sale of her practice, Dr. Barnes must “recapture” the amortization of that goodwill as ordinary income just as one does with depreciation on equipment.

However, any allocation to goodwill upon the sale of Dr. Adams’ practice is taxed as capital gains as there was no amortization of Dr. Adams’ self-created goodwill along the way.

When a dentist is incorporated, the sale of goodwill becomes even more complicated. Special care must be taken to allocate an appropriate amount of the goodwill being sold between the corporation and the individual. Much has been written on this subject, but, essentially, it comes down to the fact that a corporation can’t practice dentistry or have special skills like an individual dentist. A corporation can, however, own the latest dental equipment and technology, have a fantastic location or favorable premise lease and have an brand that resonates with the community and is carried through the entire patient experience.

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So if a dentist sells his or her incorporated practice, there are normally two allocations for goodwill-one corporate and one personal. From a tax standpoint, we know capital gains tax is lower (about half) than ordinary income tax. Fortunately, gain from the sale of business assets is not subject to the 3.8 percent Medicare investment tax. Corporations do not have capital gains tax rates and personal service corporations only the flat 35 percent bracket. Thus, in theory, it makes sense to allocate as much goodwill as is reasonable to the individual doctor and not the corporation.

However, at the end of the day, the reality is that the value of goodwill is subjective. A dentist may obtain 10 appraisals of the practice with the result being 10 different valuations. And in the practice sale and transition industry that exists today, the allocation of the price of a practice is primarily a negotiation between buyer and seller over the most advantageous tax outcome for each party.

One of the first steps a dentist should take when beginning to consider the process of retirement is to explore the value that both a dental marketing consultant and dental CPA can add. Both parties are uniquely qualified to help guide veteran dentists through one of the most important milestones, and one of the largest transactions, in their careers.