How to Structure a Home Health Agency Sale For Maximum Tax Benefit

When structuring the sale of a home health agency, a few simple ideas (and some smart lawyering) might mean the difference between paying over 45% of the sale proceeds, and a more modest 20% of the proceeds. Your transaction must be deftly negotiated though–because what’s good for a seller can impact the buyer going forward. Of course (here comes the disclaimer) you’ll want to review your specific situation with your accountant.

Selling a Health Care Company in a Stock Sale

A stock sale transaction takes place when a health care company owner simply sells his corporation’s stock (or LLC’s units) to a buyer. The stock transfers to the new owner, as well as all vestiges of ownership, such as licenses, leases, real property, assets, and contracts. It is certainly the simplest method of company transfer.

There is another tangible tax benefit to the seller: if the seller has owned the corporation’s stock for more than a year, the sale of the corporation’s stock qualifies as a long-term capital gain–and is taxed at favorable rates of near 15% (the rates have some ins and outs, but 15% is a likely rate in most transactions).

But, a stock sale my not be the favored structure from a buyer’s perspective. While taxes and Medicare liabilities will follow the agency to the new buyer regardless of the transaction’s structure, a stock sale will expose the buyer to other liabilities arising from the agency’s past operations. An example of such an operational liability might be a slip and fall injury from someone visiting the company headquarters, or an unpaid bill for services rendered to the agency.

And, a buyer may also find unfavorable allocation rules within the stock sale model. If a buyer purchases a corporation, he accepts the balance sheet as he finds it: items on the balance sheet are valued for tax purposes at book value. An example would be a $50,000 computer system previously depreciated down to $5,000–leaving very little depreciation for a new buyer.

Selling a Health Care Company in an Asset Sale

An alternative to a stock sale is an asset sale. In an asset sale, as the name implies, the assets of an ongoing enterprise are sold to a buyer. An asset sale leaves the former operating corporation or LLC in place–the prior owners remain as owners. Of course, when the assets are sold, the owners are left owning a non-operating entity that has received cash in exchange for its operating assets. The cash is then distributed to the owners.

Generally, buyers have a preference for asset sale transactions. First, a buyer in an asset sale restricts his exposure to past corporate liabilities. And, a buyer in an asset sale takes the assets with a stepped up basis–and can therefore depreciate the assets anew.
Sale of an Agency by a C-Corporation in an Asset Sale

An asset sale by a C-Corporation can produce undesirable tax consequences. In an asset sale, if a C Corporation sells its assets, the C Corporation remains intact, and the sale of assets is taxable income to the Corporation. As such, the corporate tax rate on such income is taxed up to the maximum rate of 35%. Thereafter, in the inevitable distribution of proceeds to shareholders the cash distributed is taxed as either a dividend or a long term capital gain, at a 15% rate. This dual taxation yields a hefty tax, and depending on the circumstances, can easy reach a percentage in the high 40s.

There are way to reduce this tax burden.

One fairly common method is to allocate some of the sale proceeds to a personal service contract by a shareholder/manager; for example, a non-compete agreement. Because the party to the personal contract is not the Corporation, the income bypasses the Corporation and is taxed directly to the individual. Individual income tax rates are high, but this method does avoid the double taxation outlined above.

Here’s another idea. If the Corporation’s owner can demonstrate that the owner is responsible to any extent for the business’ goodwill, then the goodwill can be attributed (either in whole or in part) to the individual rather than the corporation. This way, the owner would receive income as capital gain (with favorable tax treatment), and the income will bypass the Corporation.

Limitation on Conversion to S-Corp — § 1374

In case the burdens of C Corp taxation have you thinking “I’ll simply convert to an S-Corp immediately before the sale of my business”, the IRS has anticipated that maneuver. The IRS drafted § 1374 which imposes a C Corp tax rate (of 35 percent) if the business recognizes gains within 10 years of the conversion. There are some ins and outs that an accountant can help navigate, of course, but 1374 will prevent most conversions.

Sale of an Agency by a C Corporation in a Stock Sale

Turning now to the circumstance where a C-Corporation is sold in a stock sale, the owners own the C Corp which in turn owns the agency. The selling owners sell their stock in the C Corp, and therefore receive capital gains treatment on their proceeds. As a starting point, this is generally desirable to owners. From the buyer’s perspective, though, the buyer enjoys no step-up in its tax basis, and there is always the potential for unforeseen liabilities that would potentially be attributable to the Corporation.

Sale of an Agency by an S Corporation in an Asset Sale

S Corporation income passes through the entity to the shareholders. As such, the double-taxation incident to C Corporation income does not apply. Specifically, in an asset sale, assets sold by an S Corp cause income to flow directly to the shareholders–and are taxed as ordinary income.

The key to maximizing tax benefit in an S Corporation asset sale is how the income from the sale is allocated. Ideally, a seller will want to have some of the agency’s value characterized as capital gain rather than ordinary income. That can be achieved through the allocation ideas expressed above.

Sale of an Agency by an S Corporation in an Stock Sale

The sale of an agency through a stock sale by an S Corporation is closely akin to the sale of an agency by a C Corporation.

 

 

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