An exit strategy for all occasions
By Mark E. Battersby

Few will admit it, but almost every chiropractor thinks about eventually leaving the profession. Leaving, though, depends on having an exit strategy that deals with capital gains (or losses) on your terms.

TYPES OF SALES

In general, you can sell ownership of an incorporated chiropractic practice by either selling or redeeming the owner's stock or by selling corporate assets:

• Selling stock. This is probably easier than a redemption or asset sale, but buyers may not pay as much for stock as they would for the incorporated chiropractic practice's assets — since liabilities generally remain with the stock.

• Redemption. A redemption is payment from the corporation in exchange for some or all of the principal's shares.

A redemption is often preferable when the buyer has limited cash or borrowing ability and the owner does not want to finance the sale because corporate funds are used to redeem an owner's stock.

A combined sale-redemption transaction can also be used to bring a new owner into the practice without an existing principal withdrawing.

• Asset sales. Unlike a sale or redemption, in which ownership of the corporation is transferred from the shareholder to the purchaser or remaining shareholders, an asset sale involves transferring practice assets from the corporation to the purchaser.

The shareholders retain ownership of the corporation. However, after the assets are sold, the corporation often distributes the sales proceeds along with any remaining assets to the owner in a complete liquidation.

Buyers often prefer to purchase assets to protect themselves from existing liabilities and to be able to allocate the purchase price to assets rather than stock. In some cases, buyers may prefer to acquire stock because certain intangibles (name recognition, franchise, or favorable contracts) would not be transferred otherwise.

Selling corporate assets, though, usually has a high tax cost for the owner because it generates corporate-level gain or loss. If the sale proceeds (net of corporate-level tax paid) are distributed to the owner or liquidated, the owner recognizes capital gain or loss, based on the amount of this distribution compared to his or her stock basis.

Thus, getting the sales proceeds to the owner usually creates two levels of tax. For those owners with a low basis in their stock and facing many practice assets that have appreciated significantly, the tax bill can be high.

OTHER, LESS-TAXING OPTIONS

Although selling or redeeming stock or selling assets are common ways to exit a practice, you have other, less-taxing, options:

• ESOP. An employee stock ownership plan (ESOP) can be used to raise funds for an incorporated chiropractic practice — or to purchase part or all of the principal's shares of stock. The purchase of the owner's share is treated as an outright sale of the chiropractic operation's stock, and the owner treats the proceeds as capital gains or losses.

From the practice's standpoint, an ESOP is much like a fringe benefit for employees. The chiropractic practice can distribute profits in the form of dividends and, unlike dividends to regular shareholders, claim a tax deduction for these distributions. In fact, the practice treats all contributions to its ESOP, even amounts used to pay the principal on loans that were incurred to purchase employer securities, as a deduction — at least to the extent those distributions don't exceed 25 percent of the compensation paid to participants.

• FLP. A Family Limited Partnership (FLP) is simply a limited partnership consisting of members of a family. A limited partnership has both general partners (the ones who actually run the partnership) and limited partners (who are passive or uninvolved investors).

General partners have unlimited personal liability for partnership obligations, while limited partners have no liability beyond their capital contributions.

Typically, FLPs are formed by the older generation, who contributes assets to the partnership in return for both general partnership units and limited partnership units. The parents can then embark on a plan of giving unlimited partnership units to their children and grandchildren while retaining the general partnership units that actually control the partnership.

The result: The parents can retain control of the business and draw salary or wages from it, while sharing the profits with other family members who are taxed on those profits at a lower tax rate.

Although the IRS sometimes challenges FLPs in the courts, that should not deter you to transfer your practice, or its income, to family members. None of the IRS challenges have been successful in eliminating FLPs, nor have they severely affected any practice that closely adhered to the rules.

Although many closely-held corporations have buy/sell agreements already in place to provide a mechanism for valuing and purchasing the shares of a deceased or disabled shareholder (or a shareholder whose employment with the corporation is terminating), few provide for the retirement of the chiropractor, partner, or principal shareholder.

Utilizing an ESOP to gradually transfer the practice to employees, a FLP to transfer the practice to family members, or another tax-favored strategy recommended by your advisors will ensure that the practice you worked so hard to build and run will provide the funds necessary for retirement.

The alternative is a fire-sale of the abandoned practice's assets and a high tax bill.

Mark E. Battersby is a tax and financial advisor, freelance writer, lecturer, and author with offices in suburban Philadelphia. He can be contacted at 610-789-2480.

DISCLAIMER: The author is not engaged in rendering tax, legal, or accounting advice. Please consult your professional advisor about issues related to your practice.