Understanding the tax implications of buying or selling a practice – Additional considerations

Succession Planning

Understanding the tax implications of buying or selling a practice – Additional considerations

The fifth in a five-part series about the decision process when buying or selling a business

The fifth in a five-part series about the decision process when buying or selling a business

Additional Considerations

Whether buying the assets or the stock of a practice, the purchaser generally enters into two or three additional contractual relationships with the seller. The most common of these agreements include the:

• Consulting agreement

• Employment agreement

• Non-compete/non-solicit agreement

Note that appropriate counsel should vet all contractual agreements as they are subject to applicable state laws.

The consulting agreement differs from an employment agreement, wherein you define the specific scope of consulting services the seller will provide and the time frame for those services during the transition. In an employment agreement, the party is an employee and will be expected to act as an employee and will have differing rights and responsibilities when compared to an independent contractor/consultant. It is particularly important to understand and define the nature of the relationship, as the consulting and employment agreements are not mutually exclusive.

These types of agreements permit the buyer to claim an ordinary tax deduction for the amounts paid to the seller in his specific role as a consultant or an employee. The seller would recognize ordinary income subject to self-employment taxes, as reported on Form W-2 or Form 1099-MISC.

Non-compete/Non-solicit

If you buy business assets or stock from an individual, the last thing you want is for that person to then go into business under a different trade name and start soliciting the clients of the practice he or she just sold. To prevent this situation, the buyer typically will require the seller to enter into a non-compete/ non-solicit agreement.

The sales proceeds allocated to a non-compete/non-solicit agreement are taxed as ordinary income, and are not likely to be subject to self-employment taxes since the seller is being paid not to do something. Conversely, the paying party would not receive an immediate deduction but instead would capitalize and amortize over a period of 15 years.

Additional Tax Considerations

Why is it important to have a separate employment or consulting agreement?

It is highly unusual for a business to simply transfer from one party to another without the active engagement of the selling party. And since the seller is expected to be active in business transactions over a period of time, it is advisable that the nature of that relationship and time frame be contractually spelled out and separate from the purchase of the business’s assets or stock.

Also there may be other tax consequences arising out of the transaction and specific transactional guidance should be solicited from your own tax and/or legal counsel; some of which may include:

• Alternative minimum tax

• §338(h)(I0) election

• State and/or local taxes

• Depreciation recapture

• Medicare surtax

Tax implications can have a significant impact on a buyer’s ability to fully service the debt incurred when purchasing another practice. This is why it is extremely important to understand the cash flows on an after-tax basis when structuring a deal. Clearly an acquisition is not a transaction you would want to pursue without competent tax and legal counsel.

By discussing the tax considerations discussed in this paper with your tax and legal advisors, you may be able to avoid many unintended tax consequences. As with investment recommendations for your clients, it is not likely you let the tax tail wag the transaction dog. However, before you enter into a contract, the best advice is to follow Habit No. 2 from author Stephen Covey: “Begin with the end in mind.”

For a list of additional resources, click here

This information likely does not address the implications of each specific transaction. Please be aware that this information is intended to provide an overview only and is not a substitute for specific transaction guidance from an attorney, certified public accountant, enrolled agent or other subject matter expert. For specific transactional related advice, please consult with your own tax and/or legal counsel.

CIRCULAR 230 NOTICE: To comply with U.S. Treasury Department and IRS regulations, we are required to advise you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this transmittal is not intended or written to be used, and cannot be used, by any person for the purpose of (i) avoiding penalties under the U.S. Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this document or other related materials.



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