Valuation Strategies for More TaxEffective Physician/Dentist Practice
Transactions
November 15, 2013

W. James Lloyd, CPA/...
Introduction

#

The classification of goodwill in a transaction
can have serious tax implications for the
parties involve...
Introduction
Presentation Objectives
o Assist individuals involved with physician and dentist
practice transactions.*
o Pr...
Agenda
Medical/Dental Practice Acquisitions
Overview of Personal and Enterprise Goodwill
Practice Acquisitions Involving P...
Speakers

W. James (Jim) Lloyd is a Principal in
the valuation and dispute services
practice of Pershing Yoakley &
Associa...
Medical/Dental Practice
Acquisitions

Page 5

ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
Practice Acquisitions
Types of Acquisition Transactions
Stock/equity sale transactions:
o Stock of corporate entity
•
•

C...
Practice Acquisitions
Current Trends
Medical and dental practice transactions have
increased significantly over the past f...
Practice Acquisitions
Current Trends
• Private equity firms and management
companies also actively looking for
opportuniti...
Practice Acquisitions
Current Trends
M&A activity expected to increase further as U.S. wrestles with controlling
healthcar...
Practice Acquisitions
Rate of Acquisitions Failures
High percentage of acquisitions of physician practices fail:
o Buyer’s...
Practice Acquisitions
Rate of Acquisitions Failures
Unmet expectations of ongoing management/control by physicians
after s...
Practice Acquisitions
Deal Structure Considerations
Most practice acquisitions are structured as asset purchases.

Tax con...
Practice Acquisitions
Deal Challenges and Issues
Corporate Practice of Medicine (“CPM”) can drive an asset deal:
o

Many s...
Practice Acquisitions
Tax Challenges - C Corp Seller
If seller is C corporation, double taxation for the seller in
an asse...
Practice Acquisitions
Tax Challenges - S Corp Seller
If seller is S corporation, seller has a single layer of
federal tax ...
Practice Acquisitions
Tax Challenges - S Corp Seller
The buyer acquiring an S corporation almost always
winds up with C co...
Practice Acquisitions
Tax Challenges - LLC Seller
If seller is an LLC, tax challenges are few (business
challenges do not ...
Practice Acquisitions
Tax Challenges - Acquire Portion of or via JV
Common for buyer to have interest in the selling
physi...
Practice Acquisitions
Acquisition of C or S Corp Assets
Corporation recognizes gain and C corp pays tax.
Then, it either d...
Practice Acquisitions
Allocation of Purchase Price
In a business acquisition structured as asset deal (for tax
purposes), ...
Practice Acquisitions
Assets or Payments Outside the Entity
Non-compete of the individual physician:
o One level of tax, e...
Overview of Personal and
Enterprise Goodwill

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ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
Goodwill
Defined
“the expectancy of continued patronage”
o

Newark Morning Ledger Co. v. United States, 507 U.S. 546, 555-...
Types of Goodwill
Defined
Personal Goodwill:
o A personal asset that depends on the continued presence of a
particular ind...
Types of Goodwill
Personal vs. Enterprise Goodwill
“Accrued goodwill can be attributed to an individual employee or to a
c...
Personal Goodwill
Concept of Personal Goodwill is Not New
Martin’s Ice Cream, Co. v. Comm’r, 110 T.C. 189, 207-208 (1998)....
Personal Goodwill
Characteristics
Characteristics of Personal (i.e. Professional) Goodwill:
o Customers/patients come to t...
Enterprise Goodwill
Characteristics
Characteristics of Enterprise (i.e. Practice) Goodwill:
o Customers/patients come to t...
Practice Acquisitions Involving
Personal Goodwill and Legal
Considerations

Page 29

ATLANTA | KANSAS CITY | KNOXVILLE | T...
Navigating the
Regulatory Environment
STARK LAW

Prohibited self-referrals
for Medicare and
Medicaid patients

100 m

Road...
Navigating the
Regulatory Environment
STATE LAW REQUIREMENTS

State statutes restricting
corporate practice of
medicine
10...
Personal Goodwill
Transfer of Personal Goodwill
When considering whether personal goodwill in a particular
acquisition can...
Code on Capital Assets
IRC 1221 “capital asset” means property held by the taxpayer …
but does not include:
– Inventory
– ...
Case Law and Whether PG
is a Capital Asset
See Addendum for additional slides on some of the Case Law
It is clear that if ...
Case Law and Whether PG
is a Capital Asset
“It is settled that goodwill, as a distinct property right,
is a capital asset ...
Conclusion
PG as Capital Asset
Although it appears that most tax practitioners believe that true
personal goodwill is a ca...
Acquisitions with Personal Goodwill
Structuring the Transaction
The sale of personal goodwill should not be a tax aftertho...
Acquisitions with Personal Goodwill
Structuring the Transaction
Business success must be linked to the personal efforts,
r...
Personal Goodwill
Be Realistic!
Accurately recite characteristics making the goodwill personal.
Realistic allocation betwe...
Personal Goodwill
Facts That Can Doom PG Argument
Don’t have significant “personal goodwill” in fact.
The individual selle...
Legal Considerations
What is Needed for Court to Accept
Individual taxpayer possesses unique skills
and personal relations...
Legal Considerations
What is Needed for Court to Accept
Example of Case with almost good documentation (good generalist
at...
Acquisitions with Personal Goodwill
Tax Attributes/Benefits
Structuring the transaction with separate purchase agreements ...
Valuing Personal Goodwill

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Valuing Personal Goodwill
Factors to Consider
Key factors to consider when evaluating
personal goodwill:1
o Age and health...
Valuing Personal Goodwill
Valuation Methodologies
Common methodologies used for
valuing personal goodwill:
o With and with...
Valuing Personal Goodwill
With and Without Method
With and Without Method:
o Most commonly used method to value PG
o Quant...
Valuing Personal Goodwill
Top-Down and Bottoms-Up Methods
Top-down (purchase price allocation) Method:
o Similar to a purc...
Valuing Personal Goodwill
Excess Earnings/Compensation Methods
Excess Compensation Method:
o Estimates PG by capitalizing ...
Valuing Personal Goodwill
Non-Compete Agreements
Non-compete agreements that exist prior to the transaction can
convert an...
Valuing Personal Goodwill
Valuation Challenges and Issues
Goodwill only has value to extent it generates earnings above
re...
Valuing Personal Goodwill:
Goodwill in Divorce Law
Many family law courts across U.S. require that valuations
differentiat...
Hypothetical
Transactions

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Hypothetical Transaction 1:
Cosmetics Alterations, Inc.
Cosmetics Alterations, Inc. (a personal service corp.)
o Backgroun...
Hypothetical Transaction:
Scenario 1 Pre- & Post-Acquisition Accounting
Pre-Acquisition
Balance Sheet
December 31, 2012
Ca...
Hypothetical Transaction:
Scenario 1: All Goodwill is Enterprise
Corporate Level

Individual Level

Cash
Sales proceeds
Le...
Hypothetical Transaction:
Scenario 1A: All Goodwill is Personal
Corporate Level

Individual Level

Cash
Total sales procee...
Hypothetical Transaction
Scenario 1 Additional Alternative Facts:
o Dr. Smith started the practice years ago and is well k...
Hypothetical Transaction 2:
Outpatient Surgery Center
o Multi-specialty ASC that has been in business over 20 years
o Stru...
Hypothetical Transaction 2 (cont’d):
Sell 51%
o Sell 51% of stock of S Corp
−

Issues if disproportionate distributions to...
Hypothetical Transaction 3:
Outpatient Surgery Center
o Some facts or Hypothetical Transaction 2 except C Corporation
o Se...
Practice Acquisitions
Key Takeaways
Understand the facts and be realistic.
Must have experienced counsel for these transac...
Summary

#E

Every medical or dental practice
acquisition is unique. In acquisitions
where personal goodwill is believed t...
Case Law Addendum

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Cases are Fact Specific
Taxpayers have probably lost more cases than
won. (Examples)
Furrer v. Comm’r, 566 F.2d 1115 (9th ...
Cases are Fact Specific
Favorable cases for TP
o
o
o

Martin’s Ice Cream, Co. v. Comm’r, 110 T.C. 189 (1998). Gain
on spin...
Personal Goodwill as a
Corporate or Individual Asset
“This Court has long recognized that personal relationships of
a shar...
Legal Considerations
Cases Pre-Dating Martin Ice Cream
Providence Mill Supply Co. v. Comm’r (1925):
o Court held that good...
Legal Considerations
Court Cases - Taxpayer Wins
Martin Ice Cream v. Commissioner (1998)
o

Ruled MIC was not required to ...
Legal Considerations
Court Cases - Taxpayer Wins
H&M, Inc. v. Comm’r (2012)
o Small insurance brokerage in ND. Assets sold...
H&M, Inc. V. Comm’r
o Court found relationships (insurance co. and customer)
were those of individual not corporation (PG)...
Legal Considerations
Court Cases - Taxpayer Losses
Solomon v. Commissioner (2008)
o Court noted nothing in agreement refer...
Legal Considerations
Court Cases - Taxpayer Losses
Kennedy v. Commissioner (2010)
o In this case Mr. Kennedy had the appro...
Legal Considerations
Case Law Development
Cases usually brought when taxpayer is not recognizing intangible gain on a
liqu...
Speaker Biography
W. James Lloyd
W. James (Jim) Lloyd, CPA/ABV, ASA, CFE is a Principal in the valuation and
dispute pract...
Speaker Biography
Leigh Griffith
J. Leigh Griffith JD, LLM, CPA is the leader of the Global Trade, Tax, and
Investment Ser...
Contact Information
W. James Lloyd, CPA/ABV, ASA, CFE
Principal, Pershing Yoakley & Associates, P.C.
(865) 673-0844
jlloyd...
1 Unique

Benefits of Treating Personal Goodwill as Property in Corporate Acquisitions, Delaware Journal of Corporate Law,...
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Presentation Offers Valuation Strategies for Tax-Effective Practice Transactions

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PYA Principal Jim Lloyd co-presented a session at the 2013 AICPA Healthcare Industry Conference in New Orleans on “Valuation Strategies for More Tax-Effective Physician/Dentist Practice Transactions.”

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  • Stark:Exceptions typically require compensation to be set in advance, consistent with fair market value (FMV) and not determined in a manner that takes into account the volume or value of referrals.42 U.S.C. §1395nnAKS:Prohibits the knowingly and willful offer, payment, solicitation or receipt of remuneration for purposes of inducing or rewarding for referrals of services reimbursable by a federal health care program.42 U.S.C. §1320a-7b(b)IRS:Tax exempt hospitals/health systems must ensure that no part of its earnings “inure to the benefit of any private shareholder or individual. Transactions between tax exempt hospitals and physicians that are in excess of FMV could jeopardize the hospital’s tax exempt status.IRC Section 501(c)(3) and related regulations.
  • Presentation Offers Valuation Strategies for Tax-Effective Practice Transactions

    1. 1. Valuation Strategies for More TaxEffective Physician/Dentist Practice Transactions November 15, 2013 W. James Lloyd, CPA/ABV, ASA, CFE Principal, Pershing Yoakley & Associates, P.C. J. Leigh Griffith, JD, LLM, CPA Partner, Waller Lansden Dortch & Davis, LLP Page 0 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    2. 2. Introduction # The classification of goodwill in a transaction can have serious tax implications for the parties involved. Anticipated postacquisition tax outcomes may dictate whether a transaction even occurs. Structuring a transaction successfully requires consideration of relevant law, the unique facts and circumstances surrounding the transaction, proper documentation, proper valuation support, as well as how the parties may be financially impacted. Page 1 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    3. 3. Introduction Presentation Objectives o Assist individuals involved with physician and dentist practice transactions.* o Provide greater understanding of: • Key considerations/problem areas in physician practice acquisitions • Regulatory and legal issues, including case law • Personal versus enterprise goodwill • Methodologies and steps to valuing personal goodwill, including common hypothetical transactions * For convenience, physician practice will include dental practice in this presentation and reference to physicians will include dentists where appropriate. Concepts are applicable to other businesses as well, particularly service businesses. Page 2 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    4. 4. Agenda Medical/Dental Practice Acquisitions Overview of Personal and Enterprise Goodwill Practice Acquisitions Involving Personal Goodwill and Legal Considerations Valuing Personal Goodwill Hypothetical Physician Practice Transactions Page 3 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    5. 5. Speakers W. James (Jim) Lloyd is a Principal in the valuation and dispute services practice of Pershing Yoakley & Associates, P. C. Jim has over 25 years of experience providing valuation, forensic accounting, and other consulting services to a multitude of healthcare and other organizations across the U.S. J. Leigh Griffith JD, LLM, CPA is a tax partner at Waller Lansden Dortch & Davis, LLP and the Pass-Through Partner for Taxes magazine. Leigh has 35 years of experience practicing tax and business law, helping clients grow their businesses from start-up to multimilliondollar corporations. Page 4 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    6. 6. Medical/Dental Practice Acquisitions Page 5 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    7. 7. Practice Acquisitions Types of Acquisition Transactions Stock/equity sale transactions: o Stock of corporate entity • • C corporation S corporation (will likely become C corp after acquisition) o Membership or partnership interest acquisition (LLC or interest in LP) Asset sale transactions: o Acquisition subsidiary formed to hold assets (for profit or tax exempt) o Single member LLC o Assets integrated into existing organization Joint venture transactions: o Joint venture with physician/dentist-owned healthcare corporate entity (buyer wants ongoing physician/dentist support and interest) Page 6 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    8. 8. Practice Acquisitions Current Trends Medical and dental practice transactions have increased significantly over the past five years. Many are being bought or co-ventured by nonphysician investors. Hospitals are active acquirers, but recent trend involves combination of practices with range of other complementary practices:1 o Healthcare Partners acquisition by DaVita (kidney care services) o National Surgery Centers Holdings, Inc. (Tenet) acquisition of interests in outpatient center o Walgreens’ partnering w/physician practices to form ACOs o BCBS of Florida acquisition of Diagnostic Clinic Management Group o Dentistry 4 Children acquisition of dental practices 1 Avondale Partners, “Physician Practice M&A: Not Just for Hospitals Anymore”, May 30, 2013. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 7
    9. 9. Practice Acquisitions Current Trends • Private equity firms and management companies also actively looking for opportunities to acquire Page 8 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    10. 10. Practice Acquisitions Current Trends M&A activity expected to increase further as U.S. wrestles with controlling healthcare costs, yet still delivering high-quality outcomes: o Physicians looking to sell due to:1 • Reimbursement risks, cost of EMR, increasing costs of operating practice, access to employer expertise/resources, access to capital, more predictable compensation, fewer administrative responsibilities, access to range of employment benefits. o Hospitals looking to buy due to:1 o Healthcare reform, lack of call coverage, "defensive" mindset to be a step ahead of competitors, ability to address physician shortages, ability to improve quality of care in outpatient setting and bundled payments. Movement towards bundled payments likely to accelerate the consolidation. 1 Bob Hermann, “Physician Practice Acquisitions: How We Got Here and Key Trends”, May 13, 2013. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 9
    11. 11. Practice Acquisitions Rate of Acquisitions Failures High percentage of acquisitions of physician practices fail: o Buyer’s needs not understood by physicians o Physician’s needs not understood by buyers (particularly Private Equity) o Regulatory aspects that may limit or shape a transition are not understood (includes role of federal identification number) o Due diligence failures and fatigue Page 10 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    12. 12. Practice Acquisitions Rate of Acquisitions Failures Unmet expectations of ongoing management/control by physicians after sale Physician has “sticker shock” at high cost of specialized counsel and accounting/valuation support. The result of is use of generalist not specialized counsel representing physician: o Not knowing what is commercially acceptable o Not understanding regulatory environment o Not understanding what is transactionally important and less important o Not understanding the tax considerations Hospital or other acquiring entity using counsel not experienced in physician acquisitions Page 11 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    13. 13. Practice Acquisitions Deal Structure Considerations Most practice acquisitions are structured as asset purchases. Tax consequences for buyer and seller can be key determinant as to whether a transaction is completed: o Sellers generally prefer stock sales. • • o Avoid double taxation (corporate and individual levels) Perceived to be simpler (may be surprised by indemnification obligations) Buyers generally prefer asset purchases. • Step-up in tax basis of assets, resulting in lower taxes • Can amortize goodwill, among other intangibles, over a 15-year period • Easier to deal with unwanted assets (simply not purchase) • Avoid inheritance of any contingent and/or unknown liabilities: • Malpractice, environmental, sexual harassment, past billing, licensing irregularities with government, among others. Page 12 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    14. 14. Practice Acquisitions Deal Challenges and Issues Corporate Practice of Medicine (“CPM”) can drive an asset deal: o Many states prohibit corporations from practicing medicine or employing a physician to provide professional medical services. (exceptions in some states in connection with hospitals, HMOs, and professional corps) o Asset purchase with management contract and assignable right for friendly physician to purchase stock Double taxation: Sellers often forced to structure as asset sale, which increases cost of selling due to double layer of taxation Shareholder(s) who refuse(s) to sell: Is there mechanism to force sale and what are implications? What are physician “rights” or “control” after sale? Physician continued equity participation after sale? Employment and non-compete agreements: Compensation after the sale, regulatory/reimbursement restrictions Page 13 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    15. 15. Practice Acquisitions Tax Challenges - C Corp Seller If seller is C corporation, double taxation for the seller in an asset sale is a significant issue: o Corporate tax at 35% plus state tax (typically 6% to 8%) o Tax on shareholder/physicians on liquidation (20% capital gains and 3.8% unearned income Medicare tax [funds not go to Medicare] plus state tax [5% to 10%]) o Physician owner with corporation with low basis assets gets about 42.6 cents to the dollar after tax: o Combined 40% entity level tax [35% federal income and 5% state net after itemized deduction] and combined 29% (20% + 3.8 Medicare Tax + 5.2 net state tax) federal/state individual tax on dividend or liquidation o 100-40=60; 60 x 29% = 17.4 60-17.4= 42.6 Page 14 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    16. 16. Practice Acquisitions Tax Challenges - S Corp Seller If seller is S corporation, seller has a single layer of federal tax (capital gain and some ordinary income): o However, proceeds must be distributed in accordance with stock ownership if not paid out in compensation (one class of stock rule for S corporations). o Compensation bonus for disproportion can be effective (costs capital gains to recipient) if the amount’s not too great. • Non-deductible compensation a problem • Disguised dividend a bigger problem o Rollover problems - will be C corporation in future or liquidated Page 15 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    17. 17. Practice Acquisitions Tax Challenges - S Corp Seller The buyer acquiring an S corporation almost always winds up with C corporation for ongoing tax: o Unless 336(e) or 338(h)(10) election can be made, no basis step up (big ongoing tax cost to buyer). o Even buyers of stock are now wanting to have significant portion of purchase price for something other than stock so they can obtain tax amortization if above elections are not possible. o Potential contingent and unknown liabilities from the past and in some states entity level of state tax on S corporation assets. Page 16 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    18. 18. Practice Acquisitions Tax Challenges - LLC Seller If seller is an LLC, tax challenges are few (business challenges do not change): o One level of federal tax (whether sell assets or membership interest): • • • • Mostly capital gain, some ordinary income (Seller) 754 election for Buyer Disguised sale rules Beware of 197(f) o Special allocations o Special distributions o State tax planning • • Entity level tax? Recognition of 754 election? Page 17 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    19. 19. Practice Acquisitions Tax Challenges - Acquire Portion of or via JV Common for buyer to have interest in the selling physicians continuing to own up to 49% of ongoing enterprise – particularly in the outpatient or ancillary arena: o If the S or C corp of physicians is involved, a joint venture (typically LLC or LP) occurs between the physician entity and the buyer: o Assets transferred by physician entity to JV in exchange for cash and interest in JV • Winds up being an acquisition of a portion of the assets for federal tax purposes o All the problems of asset sale touched on earlier are present, plus a few additional issues. Page 18 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    20. 20. Practice Acquisitions Acquisition of C or S Corp Assets Corporation recognizes gain and C corp pays tax. Then, it either distributes net proceeds in liquidation or by dividend with or without a layer of additional compensation. o If additional compensation, will it be deductible? • If not, double tax if C corporation or potential loss of S status (not neat for the S shareholders getting less to pay tax on S gain going to another shareholder or for any of the shareholders if S status is lost). o If large purchase price (for example, an $80 million transaction involving 10 physician owners of an ASC for 80%), how do you effectively minimize? Is there an asset or something outside the corporation (C corp and sometimes S corp) that is being bought? Page 19 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    21. 21. Practice Acquisitions Allocation of Purchase Price In a business acquisition structured as asset deal (for tax purposes), the buyer and seller must allocate purchase price to assets bought/sold: o Value of intangible assets (including goodwill) is driven by a market advantage giving rise to “excess earnings,” or earnings in excess of normal returns on business’s operating assets. o Requires consideration of the existence of goodwill and, in turn, the presence of personal and/or enterprise goodwill o Consideration of any non-compete(s) with seller(s) and resulting impact on goodwill o IRC 1060 allocations and if S corporation involved 6043A * Based on data from Pratt’s Stats, excluding specialty practices, the average non-compete agreement value to net selling price is approximately 15%. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 20
    22. 22. Practice Acquisitions Assets or Payments Outside the Entity Non-compete of the individual physician: o One level of tax, even if ordinary income, is better than two levels of tax. o Be sure individual physician is in position to compete; announcement of intention to retire and move away is not a good fact pattern. Personal goodwill: o Must be real - not always available o Degree of risk on tax treatment o Must be valued and the valuation must be credible o Parties do not have adverse tax interests Page 21 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    23. 23. Overview of Personal and Enterprise Goodwill Page 22 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    24. 24. Goodwill Defined “the expectancy of continued patronage” o Newark Morning Ledger Co. v. United States, 507 U.S. 546, 555-56 (1992) (quoting Boe v. Comm’r, 307 F.2d 339, 343 (9th Cir. 1962)). Justice Story: o “the advantage or benefit, which is acquired by an establishment, beyond the mere value of the capital, stock, funds, or property employed therein, in consequence of the general public patronage and encouragement which it receives from constant or habitual customers, on account of its local position, or common celebrity, or reputation for skill or affluence, or punctuality, or from other accidental circumstances or necessity, or even from ancient partialities or prejudices” – Metropolitan Bank v. St. Louis Dispatch Co., 149 U.S. 436, 446 (1893) (quoting J. Story, Partnerships 99 (1841)). “the value of a trade or business attributable to the expectancy of continued customer patronage” Treas. Reg. 1.197-2(b)(1). Page 23 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    25. 25. Types of Goodwill Defined Personal Goodwill: o A personal asset that depends on the continued presence of a particular individual and may be attributed to the individual owner’s personal skill, training or reputation.1 Enterprise Goodwill: o An asset of the business and may be attributed to a business by virtue of its existing arrangements with supplies, customers or others, and its anticipated future customer base due to factors attributable to the business.1 1 Supreme Court of Appeals of West Virginia, May v. May, (No. 31123) ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 24
    26. 26. Types of Goodwill Personal vs. Enterprise Goodwill “Accrued goodwill can be attributed to an individual employee or to a company, depending on the employment relationship between the two.” Howard v. United States, 2010 U.S. Dist. LEXIS 77251, No. CV-08-365-RMP, at *7 (E.D. Wa. July 30, 2010) (citing Martin Ice Cream Co. v. Comm’r, 110 T.C. 189, 207 (1998)). “a professional practice’s goodwill can attach to both the professional and the business” H&M, Inc. v. Comm’r, T.C. Memo 2012-290, *P19 (T.C. 2012) (citing Schilbach v. Comm’r, T.C. Memo 1991-556). “there is no salable goodwill where, as here, the business of a corporation is dependent upon its key employees, unless they enter into a covenant not to compete with the corporation or other agreement whereby their personal relationships with clients become the property of the corporation” Norwalk v. Comm’r, 1998 Tax Ct. Memo LEXIS 281, at *18 (citing Martin Ice Creme Co., 110 T.C. at 207). “goodwill is a vendible asset which can be sold with a professional practice” Id. at *14 (citing LaRue v. Comm’r, 37 T.C. 39, 44 (1961)). Page 25 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    27. 27. Personal Goodwill Concept of Personal Goodwill is Not New Martin’s Ice Cream, Co. v. Comm’r, 110 T.C. 189, 207-208 (1998). “This Court has long recognized that personal relationships of a shareholderemployee are not corporate assets when the employee has no employment contract with the corporation. Those personal assets are entirely distinct from the intangible corporate asset of corporate goodwill.” Cites – Estate of Taracido v. Comm’r, 72 T.C. 1014, 1023 (1979) – Cullen v. Comm’r, 14 T.C. 368, 272 (1950) – MacDonald v. Comm’r, 3 T.C. 720, 727 (1944) – Providence Mill Supply Co. v. Comm’r, 2 B.T.A. 791, 193 (1925). Page 26 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    28. 28. Personal Goodwill Characteristics Characteristics of Personal (i.e. Professional) Goodwill: o Customers/patients come to the business because of the individual’s reputation, etc. Assumption is if individual were not there, the clients would likely go elsewhere.1 o Key factors include: individual skills, knowledge, reputation, personality, relationships, etc.1 o Often applicable in businesses that are technical, specialized, or professional (such as medical or dental practices), or have few customers or suppliers. o No non-compete exists between selling shareholder and selling company. o Relevant in divorce law - A non-marital asset in some state jurisdictions. Other states make no distinction. 1 BVR’s Guide to Personal v. Enterprise Goodwill, 2009 Edition. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 27
    29. 29. Enterprise Goodwill Characteristics Characteristics of Enterprise (i.e. Practice) Goodwill: o Customers/patients come to the business because of its reputation, brand awareness, etc. in the market.1 o Reputation of individual service providers is less significant. o Key factors include: location, staff/workforce, website, facilities, and reputation/brand of the entity.1 o Generally more applicable for larger businesses with formal organizational structure, processes, and controls, diversified customer base, deep management team and/or long-term customer contracts o Non-compete exists between selling shareholder and selling company. 1 BVR’s Guide to Personal v. Enterprise Goodwill, 2009 Edition. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 28
    30. 30. Practice Acquisitions Involving Personal Goodwill and Legal Considerations Page 29 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    31. 31. Navigating the Regulatory Environment STARK LAW Prohibited self-referrals for Medicare and Medicaid patients 100 m Road ANTI-KICKBACK STATUTE Knowingly and willful offers, payments, or receipts for referrals Menu Page 30 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    32. 32. Navigating the Regulatory Environment STATE LAW REQUIREMENTS State statutes restricting corporate practice of medicine 100 m Road IRS-NFP REQUIREMENTS IRC Section 501(c) 3 requirements; Prohibits private inurement/benefit Menu Page 31 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    33. 33. Personal Goodwill Transfer of Personal Goodwill When considering whether personal goodwill in a particular acquisition can be transferred to the buyer, one is really asking, “Can the personal goodwill be converted into enterprise goodwill?” o Possibly, depending on form of personal goodwill, consideration of facts and circumstances, and through contractual obligations o Forms of personal goodwill include: o Relationships o Skill o Knowledge o Reputation Page 32 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    34. 34. Code on Capital Assets IRC 1221 “capital asset” means property held by the taxpayer … but does not include: – Inventory – Trade or business property subject for 167 depreciation or real property used in trade or business – Certain copyright, literary, musical or artistic compositions – Accounts receivable – Certain publications of US Government – Certain commodities derivative financial instruments held by commodities dealer – Hedging transaction – Supplies of type regularly used or consumed by TP in ordinary course of trade or business Page 33 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    35. 35. Case Law and Whether PG is a Capital Asset See Addendum for additional slides on some of the Case Law It is clear that if the facts are not real, the documentation and negotiations are not appropriate, or if the consideration is not adequately supported, the taxpayer will lose because the IRS and courts will find PG not sold or failure of taxpayer proof. Some commentators question whether PG yields capital gains. Although no case has explicitly held that PG is a capital asset of the shareholder, it is implied in some of the cases and appears to be the view of a majority of the practitioners as the transactions are not uncommon. There are no cases holding that PG is NOT a capital asset. Page 34 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    36. 36. Case Law and Whether PG is a Capital Asset “It is settled that goodwill, as a distinct property right, is a capital asset under the tax laws.” Comm’r v. Killian, 314 F.2d 852, 855 (5th Cir. 1963). “Whether goodwill does exist as a capital asset of a sole proprietor and if so whether such goodwill was transferred are questions of fact in each case.” Kennedy v. Comm’r, 2010 Tax Ct. Memo LEXIS 241, at *25 (quoting Butler v. Comm’r, 46 T.C. 280, 287 (1966)). Page 35 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    37. 37. Conclusion PG as Capital Asset Although it appears that most tax practitioners believe that true personal goodwill is a capital asset that can be sold and transferred, there are many who do not. PG transactions are not uncommon. One group of academic authors thinks personal goodwill is non-transferable, and if an entity paid for the entertainment and other relationship/reputation building, etc., that under Code 482 principles, even if owned by the individual, it is a tax asset of the corporation. o Bret Wells & Craig Bergez, Disposable Personal Goodwill, Frosty the Snowman, and Martin Ice Cream All Melt Away in the Bright Sunlight of Analysis, 91 Neb. L. Rev. 170 (2012). Page 36 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    38. 38. Acquisitions with Personal Goodwill Structuring the Transaction The sale of personal goodwill should not be a tax afterthought. It must be planned in advance and be important to the seller. Kennedy. Have separate sale of personal goodwill agreement that is signed in personal capacity. Solomon v. Comm’r, 2008 Tax Ct. Memo LEXIS 107 (Apr. 16, 2008). Have employment agreement with purchasing corporation as evidence that the individual taxpayer is taking steps to transfer the personal goodwill. Muskat v. United States, 2008 U.S. Dist. LEXIS 29674 (D.N.H. Apr. 2, 2008); Solomon. Seller of personal goodwill enters into non-compete with purchaser as part of the PG transaction to transfer personal relationships to purchaser. Cf. Norwalk v. Comm’r and O’rear v. Comm’r. * If documented properly, one treatise states treating goodwill as an individual asset should not increase the odds of having the purchase of goodwill recharacterized as the payment for a non-compete covenant. Tax Planning for Corporations and Shareholders 10.03[2][c][vii]. Page 37 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    39. 39. Acquisitions with Personal Goodwill Structuring the Transaction Business success must be linked to the personal efforts, relationships, or talents of individual owner(s): o Businesses where owner is not intimately involved and business is not dependent on personal relationships/talents of owner may be successfully challenged if claiming personal goodwill in transaction. Tax Court found personal goodwill not sold by TP as no evidence customer relationships truly based upon shareholder’s relationships, written agreement did not expressly state selling personal goodwill, and shareholder did not enter into consulting or employment agreement, only a non-compete. Solomon v. Comm’r. o If not working for buyer after transaction, need to have affirmative contractual obligations to assist in transferring the PG and honor the obligations. Page 38 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    40. 40. Personal Goodwill Be Realistic! Accurately recite characteristics making the goodwill personal. Realistic allocation between personal goodwill and other aspects of purchase price, including payment for services and subsequent non-compete. H&M. Realistic allocation is properly documented: o Planned in advance and not as a tax afterthought. Kennedy. o Have separate sale of personal goodwill agreement that is signed in personal capacity. Solomon v. Comm’r, 2008 Tax Ct. Memo LEXIS 107 (Apr. 16, 2008). o Have employment agreement with purchasing corporation as evidence that the individual taxpayer is taking steps to transfer the personal goodwill. See Muskat v. United States, 2008 U.S. Dist. LEXIS 29674 (D.N.H. Apr. 2, 2008); Solomon. Page 39 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    41. 41. Personal Goodwill Facts That Can Doom PG Argument Don’t have significant “personal goodwill” in fact. The individual seller has existing and/or historic non-compete with selling entity. Long-term employment contracts in place (perhaps even those lacking non-compete) as long as required to keep working full time. Even if non-compete terminated after certain period of time, one district court said that the classification does not change to personal goodwill: o Howard v. United States (sole employee of corporation he formed with non-compete in effect from 1980-2002). o Unsuccessfully argued the transaction terminated the non-compete. Page 40 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    42. 42. Legal Considerations What is Needed for Court to Accept Individual taxpayer possesses unique skills and personal relationships. Robert W. Wood, The Emperor of Ice Cream, Dentists, and Personal Goodwill, TAX NOTES TODAY, Nov. 15, 2010. Examples: o Offered a job because of relationships developed. Martin Ice Cream. o Clients would follow the employee if he left. Norwalk. o Has a reputation in the industry or community for being the “go to guy.” H&M v. Comm’r, T.C. Memo 2012-290 (2012). No non-compete prior to transaction and perhaps no longterm binding employment agreement. Proper transaction documentation and valuation support. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 41
    43. 43. Legal Considerations What is Needed for Court to Accept Example of Case with almost good documentation (good generalist attorney), no valuation support and Taxpayer loses. Kennedy v. Comm’r. 2010 Tax Court Memo LEXIS 241. o Three documents – asset purchase, consulting agreement with non-compete, and document for sale of PG. − Technical problem as corp. and individual both sold relationship/client list. o ERISA consultant whose clients had been with him for years. o PG came up after economics of deal were developed and by tax advisor as way to save taxes (“tax-motivated afterthought”). o The tax advisor’s percentage for PG had no support. o TP appears to be obligated to work for less than fair market value. o Court found TP failed on burden of proof. o Court discusses and distinguishes cases with PG. o Finds payments for services and non-compete, zero for PG. Page 42 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    44. 44. Acquisitions with Personal Goodwill Tax Attributes/Benefits Structuring the transaction with separate purchase agreements for the business and for personal goodwill may produce tax benefits: o Buyer may be entitled to amortization deductions for the personal goodwill under IRC Section 197. o Does not trigger entity-level gain on the sale of personal goodwill. o Seller’s gain from sale of personal goodwill is believed to be taxed at capital gains tax rate. Even with favorable facts, without appropriate valuation support, you likely lose. o Taxpayer has initial burden of proof and if present credible evidence and certain other criteria are met, burden shifts to IRS. IRC 7491(a). Kennedy v. Comm’r. o IRS and state tax authorities may even argue that gain was recognized at entity level and then distributed to owner for double taxation and other collateral tax effects. Howard v. United States and H&M, Inc. Page 43 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    45. 45. Valuing Personal Goodwill Page 44 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    46. 46. Valuing Personal Goodwill Factors to Consider Key factors to consider when evaluating personal goodwill:1 o Age and health of the professional o Professional’s demonstrated earning power o Professional’s reputation in the community for judgment, skill, and knowledge o Professional’s comparative professional success o Nature and duration of the professional’s practice, either as a sole proprietor or contributing member of a partnership or professional corporation o Professional’s vender relationships, if relevant 1 BVR’s Guide to Personal v. Enterprise Goodwill, 2009 Edition. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 45
    47. 47. Valuing Personal Goodwill Valuation Methodologies Common methodologies used for valuing personal goodwill: o With and without method (most common ) o Top-down (or purchase price allocation) method o Bottoms-up method o Excess earnings/compensation methods Page 46 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    48. 48. Valuing Personal Goodwill With and Without Method With and Without Method: o Most commonly used method to value PG o Quantifies the value of PG by calculating the impact of the current owner(s) on the cash flows on the business o Business value is calculated “with and without” the business owner(s). The difference in the resulting values is attributed to PG. o Focuses on compensation as the key to valuing PG Page 47 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    49. 49. Valuing Personal Goodwill Top-Down and Bottoms-Up Methods Top-down (purchase price allocation) Method: o Similar to a purchase price allocation in that it quantifies total goodwill of the entity by subtracting the estimated fair market value of the entity’s tangible and identifiable intangible assets from the purchase price. o Residual goodwill is then allocated between personal and corporate goodwill based on various qualitative and/or quantitative factors. Bottoms-up Method: o Estimates and then adds the value of all tangible and intangible assets, assuming the departure of the individual(s). One can then compare this value to the estimated value of the business assuming retention of the individuals with PG. Page 48 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    50. 50. Valuing Personal Goodwill Excess Earnings/Compensation Methods Excess Compensation Method: o Estimates PG by capitalizing excess actual earnings capacity for subject individual(s) over fair market value compensation for individuals with similar skills and experience. Excess Earnings Method: o Returns on tangible and identifiable intangible assets can be determined, with PG representing a residual or “excess earnings” value. Page 49 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    51. 51. Valuing Personal Goodwill Non-Compete Agreements Non-compete agreements that exist prior to the transaction can convert any PG into enterprise goodwill. Non-compete agreements entered into during the transaction can support an allocation to PG. o With a non-compete, a greater percentage of goodwill will generally be made up of transferable PG.1 o Some believe a non-compete will represent the value of PG, assuming value left if the non-compete is deducted as the value buyer would pay if seller continued to compete. However, a non-compete will rarely represent all of the PG.1 There are several methods used to value non-competes: o With and without method, 11 factor “economic reality test”, etc. 1 BVR’s Guide to Personal v. Enterprise Goodwill, 2009 Edition. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 50
    52. 52. Valuing Personal Goodwill Valuation Challenges and Issues Goodwill only has value to extent it generates earnings above reasonable rate of return on assets utilized plus adequate compensation to labor employed:1 o What is a reasonable rate of return on tangible and intangible assets? • Many practitioners underestimate the required rates of return (overvalue goodwill) o What is adequate compensation for services provided by owner? • Many underestimate cost of a substitute individual who would provide comparable services (overvalue goodwill) o Many practitioners use too low a cap rate (or multiple) on excess earnings (overvalue goodwill). 1 BVR’s Guide to Personal v. Enterprise Goodwill, 2009 Edition. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 51
    53. 53. Valuing Personal Goodwill: Goodwill in Divorce Law Many family law courts across U.S. require that valuations differentiate between personal (or professional) and enterprise (or practice) goodwill: o PG not considered marital asset subject to distribution; instead represents future earnings potential from individual’s personal attributes. o Any value from the personal attributes is excluded from marital estate to prevent double burden to an individual’s future income (property settlement and maintenance/alimony). o Most often applied to professional services businesses. o Assumption for PG (except any transferred) is continued contribution by person to whom the PG is attached. Page 52 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    54. 54. Hypothetical Transactions Page 53 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    55. 55. Hypothetical Transaction 1: Cosmetics Alterations, Inc. Cosmetics Alterations, Inc. (a personal service corp.) o Background information: − A plastic surgery practice, Cosmetics Alterations, Inc., is owned 100% by Dr. Beverly Smith. − Dr. Smith sells the practice in an asset sale (excluding A/R and liabilities) to a third-party for $5 million, on December 31, 2012. − The fair market value of identifiable tangible and intangible assets is $1.3 million, with $3.7 million attributed to goodwill. How does the categorization of goodwill affect Dr. Smith’s aftertax proceeds? Page 54 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    56. 56. Hypothetical Transaction: Scenario 1 Pre- & Post-Acquisition Accounting Pre-Acquisition Balance Sheet December 31, 2012 Cash Accounts receivable Inventory Current Assets Net fixed assets Intangible assets Other assets Total assets Current liabilities Long-term liabilities Total liabilities Equity Total liabilities and equity $ $ $ $ Post-Acquisition Purchase Price Allocation January 1, 2013 700,000 400,000 1,100,000 Cash Accounts receivable Inventory Less: liabilities assumed Working capital purchased $ 150,000 1,250,000 Net fixed assets Medical records Goodwill Total assets* 300,000 600,000 3,700,000 $ 5,000,000 700,000 700,000 550,000 1,250,000 400,000 400,000 * Total sales price of $5 million, excluding accounts receivable and current liabilities. Page 55 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    57. 57. Hypothetical Transaction: Scenario 1: All Goodwill is Enterprise Corporate Level Individual Level Cash Sales proceeds Less: Cost basis of assets Gain before tax Less: Federal tax liability (35%)1 Net cash before individual tax Cash Tax $5,000,000 $5,000,000 (550,000) 4,450,000 ($1,557,500) $1,557,500 $3,442,500 Corporate cash proceeds Less: Cost basis Long-term capital gain Less: Capital gains tax (23.8%)2 Net cash proceeds Tax $3,442,500 $3,442,500 0 3,442,500 ($819,315) $819,315 $2,623,185 Summary of Proceeds Sales proceeds Less: Federal corporate taxes Less: Capital gains tax Net cash proceeds (individual) $5,000,000 ($1,557,500) ($819,315) $2,623,185 1 Federal tax assumed at 35% rate for personal service corporations. State tax is disregarded for ease of illustration. 2 Capital gains rate assumed at 23.8% (20% rate for individual income greater than $450,000 plus an additional 3.8% unearned income Medicare tax. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 56
    58. 58. Hypothetical Transaction: Scenario 1A: All Goodwill is Personal Corporate Level Individual Level Cash Total sales proceeds Less: Personal goodwill Sales proceeds for corporate Less: Cost basis of assets Gain before tax Less: Federal tax liability 1 Net cash before individual tax Cash Tax $5,000,000 (3,700,000) 1,300,000 ($262,500) $1,037,500 $5,000,000 (3,700,000) 1,300,000 (550,000) 750,000 $262,500 Corporate cash proceeds Plus: Personal goodwill Subtotal Less: Cost basis Long-term capital gain 2 Less: Capital gains tax (23.8%) Net cash proceeds Tax $1,037,500 3,700,000 4,737,500 $1,037,500 3,700,000 4,737,500 0 4,737,500 ($1,127,525) $1,127,525 $3,609,975 Summary of Proceeds Sales proceeds Less: Federal corporate taxes Less: Capital gains tax Net cash proceeds (individual) $5,000,000 ($262,500) ($1,127,525) $3,609,975 1 Federal tax assumed at 35% rate for personal service corporations. State tax is disregarded for ease of illustration. 2 Capital gains rate assumed at 23.8% (20% rate for individual income greater than $450,000 plus an additional 3.8% unearned income Medicare tax. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 57
    59. 59. Hypothetical Transaction Scenario 1 Additional Alternative Facts: o Dr. Smith started the practice years ago and is well known in the community. o Dr. Smith is age 65 and has some health issues. o Dr. Smith has a non-compete with the Practice. o The Practice has one employed (i.e. non-owner) physician who has been practicing at the clinic for a number of years and has a following of patients that ask for him. o Dr. Smith will not execute a non-compete with buyer. o Dr. Smith has a 50% co-shareholder, Dr. Jones, who is mid-30s and recently established. Dr. Jones’ buy-in price was based on net book value at the time. ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY Page 58
    60. 60. Hypothetical Transaction 2: Outpatient Surgery Center o Multi-specialty ASC that has been in business over 20 years o Structured as an S Corporation o Currently has 10 physician owners (10% each) o Significant percentage of the ASC’s revenue is generated by only 3 of the 10 doctors. o Compensation of the 10 docs varies substantially o Private equity firm interested in buying 51% interest for $10,000,000 Page 59 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    61. 61. Hypothetical Transaction 2 (cont’d): Sell 51% o Sell 51% of stock of S Corp − Issues if disproportionate distributions to shareholders − Cease being S corporation; All capital gain on sale, future earnings taxed at corporate level and dividends − Purchaser unable to have stepped-up basis or consolidated tax return; Does not receive full dividends received deduction o Sell 51% of assets of S Corporation and S Corp and Acquiror contribute to new LLC or LP − Issue of how distribute proceeds − Reasonable compensation? − Do non-competes and long-term employer agreement exist? − 197(f). Will purchaser be able to amortize? Page 60 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    62. 62. Hypothetical Transaction 3: Outpatient Surgery Center o Some facts or Hypothetical Transaction 2 except C Corporation o Sell 51% of stock 1. Purchaser not able to have consolidated tax return or stepped up basis 2. Sellers have capital gain. In future, will have dividends from operations. 3. Purchaser will not have 100% dividend received deduction (only 80%). o Sell 51% of assets and corp and purchaser contribute to new LLC or LP 1. Double tax or some shareholder comp (to extent reasonable) 2. 197(f) o Corp sets up new LLC with another owner and transfers assets to LLC and subsequently sells LLC interest. Page 61 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    63. 63. Practice Acquisitions Key Takeaways Understand the facts and be realistic. Must have experienced counsel for these transactions. Must have strong valuation expertise and written proof. The IRS does not like and foot-faults will lose the serve. Understand risk/reward for all parts of the transaction, including any PG component. PG transactions are done on a regular basis. Page 62 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    64. 64. Summary #E Every medical or dental practice acquisition is unique. In acquisitions where personal goodwill is believed to exist, consideration of the facts and circumstances and a thorough valuation are critical in order to determine the appropriate allocations to personal and/or enterprise goodwill and understand the resulting tax implications. Page 63 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    65. 65. Case Law Addendum Page 64 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    66. 66. Cases are Fact Specific Taxpayers have probably lost more cases than won. (Examples) Furrer v. Comm’r, 566 F.2d 1115 (9th Cir. 1977) Jones v. United States, 355 F.Supp.2d 1292 (S.D. Ala. 2004) Solomon v. Comm’r, 2008 TCM LEXIS 107 Kennedy v. Comm’r, 2010 TCM LEXIS 241 Howard v. United States, 2010 U.S. Dist. LEXIS 77251 (ED Wash, 2010) o S. Tulsa Pathology Lab. V. Comm’r, 118 T.C. 84 (2002) o o o o o Page 65 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    67. 67. Cases are Fact Specific Favorable cases for TP o o o Martin’s Ice Cream, Co. v. Comm’r, 110 T.C. 189 (1998). Gain on spin-off. Norwalk v. Comm’r, 76 T.C.M. (CCH) 208 (1998) CPA firm liquidating H&M, Inc. v. Comm’r, T.C.M. (2012) insurance salesman (IRS attempting to tax corporation owned by individual on payment to individual) Page 66 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    68. 68. Personal Goodwill as a Corporate or Individual Asset “This Court has long recognized that personal relationships of a shareholder-employee are not corporate assets when the employee has no employment contract with the corporation. Those personal assets are entirely distinct from the intangible corporate asset of corporate goodwill.” o Martin Ice Cream Co., 110 T.C. at 207 (citing Estate of Tardido v. Comm’r, 72 T.C. 1014, 1023 (1979); Cullen v. Comm’r, 14 T.C. 368, 372 (1950); MacDonald v. Comm’r, 3 T.C. 720, 727 (1944); Providence Mill Supply Co. v. Comm’r, 2 B.T.A. 791, 793 (1925)). Page 67 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    69. 69. Legal Considerations Cases Pre-Dating Martin Ice Cream Providence Mill Supply Co. v. Comm’r (1925): o Court held that goodwill could not be included in invested capital because it was based on the personal characteristics and qualifications of a salesman who formed the company. O’Rear v. Comm’r (1933): o Professional can’t sell goodwill that attaches to his practice except by refraining from practice. MacDonald v. Comm’r (1944): o Complete liquidation where liabilities exceeded value of tangible assets; IRS argued that goodwill increased value to exceed liabilities; Court said that goodwill belonged to the insurance salesman personally. Page 68 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    70. 70. Legal Considerations Court Cases - Taxpayer Wins Martin Ice Cream v. Commissioner (1998) o Ruled MIC was not required to recognize gain as it wasn’t the owner of assets sold. Assets were personal to Arnold and were intangible relationships with supermarket owners. Arnold’s personal goodwill was sold, which was never owned by SIC/MIC. o Key to decision was absence of non-compete agreement between Arnold and MIC or SIC. Having never transferred Arnold’s expertise or relationships, they remained his personal assets. Norwalk v. Commissioner (1998) o Court ruled in favor of shareholders, stating it was “the personal ability, personality, and reputation…clients sought.” o Key to decision was lack of non-compete agreements, that if shareholders left corporation, clients would follow, and court attributed no value to the business independent of accountants themselves. Page 69 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    71. 71. Legal Considerations Court Cases - Taxpayer Wins H&M, Inc. v. Comm’r (2012) o Small insurance brokerage in ND. Assets sold to bank and bank employed agent and had deferred compensation and other payments not contingent on agent living. − The old corporation continued in existence. o IRS wanted payments reattributed to corporation and then (apparently) dividend to shareholder. − IRS unsuccessful. − Individual return was not before the court. IRS was attempting to tax corporation. Page 70 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    72. 72. H&M, Inc. V. Comm’r o Court found relationships (insurance co. and customer) were those of individual not corporation (PG) o Not taxable to corporation o Did not address character of gain/income as issue not before court. Phrased, “not necessary for us to determine the exact allocation between what he was paid for his services to the agency, his personal goodwill, and his promise not to compete since Schmeet’s individual tax liability is not before us.” Page 71 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    73. 73. Legal Considerations Court Cases - Taxpayer Losses Solomon v. Commissioner (2008) o Court noted nothing in agreement referenced sale of personal goodwill. Value of company was not attributable to service or relationships of the Solomons, and because it was not service business, it did not depend on owners for success. o Although sellers had non-competes, they did not sign consulting or employment agreements, so personal attributes weren’t available to buyer after sale. Concluded the proceeds paid directly to shareholders were attributable to non-competes rather than customer list or personal goodwill. . Page 72 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    74. 74. Legal Considerations Court Cases - Taxpayer Losses Kennedy v. Commissioner (2010) o In this case Mr. Kennedy had the appropriate paperwork (with some flaws) and lost! Sale of corporate assets listed same clients that Mr. Kennedy was basis of Mr. Kennedy’s PG. o The PG was added toward the end of the negotiations and did not change the economic terms. o No valuation support! o Court believed payment was for providing ongoing services could be considered goodwill; however, in this case, believed payments were for services, not for PG. . Page 73 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    75. 75. Legal Considerations Case Law Development Cases usually brought when taxpayer is not recognizing intangible gain on a liquidation or on a sale of all assets of a business. IRS attacks whether intangible is asset of an entity, payment for services, or payment for subsequent non-compete, both of which are ordinary income. IRS has not historically attacked whether PG is a capital asset, but whether there is PG in the specific case. o E.g., Kennedy v. Comm’r: Kennedy argued for capital gain treatment because part of sale of consulting business was for PG. IRS countered that payment was for subsequent non-compete agreement and for services (Kennedy remained employed as a consultant). Neither court nor IRS addressed PG as capital gain. o E.g., Jones v. United States: upon retirement, State Farm employee attempted to classify termination payments as PG to get capital gain treatment. The court determined agent did not own the goodwill and second, the termination payments were made by the insurance company and not by the party purchasing the assets the agent owned. Page 74 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    76. 76. Speaker Biography W. James Lloyd W. James (Jim) Lloyd, CPA/ABV, ASA, CFE is a Principal in the valuation and dispute practice of Pershing Yoakley & Associates, P.C. Jim has over 25 years of experience providing valuation, economic damages, forensic accounting, and other consulting services to a multitude of healthcare and other organizations across the U.S. Significant healthcare experience includes Ambulatory Surgery Centers, Cancer Centers, Dialysis Centers, Hospitals, Imaging Centers, Pharmacies, Pharmaceutical Manufacturers, Physician Practices, and Retirement/Assisted Living Facilities, among others. In addition to being a Certified Public Accountant (CPA), Jim also holds the following professional credentials: Accredited Senior Appraiser (ASA), Accredited in Business Valuation (ABV), and Certified Fraud Examiner (CFE). Jim is a frequent speaker and has authored multiple articles on various valuation and dispute related topics. Mr. Lloyd has substantial expert testimony experience in federal and various state and local courts and arbitration proceedings across the U.S. Page 75 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    77. 77. Speaker Biography Leigh Griffith J. Leigh Griffith JD, LLM, CPA is the leader of the Global Trade, Tax, and Investment Services group at Waller Lansden Dortch & Davis, LLP. Leigh has 35 years of experience practicing tax and business law, helping clients grow their businesses from start-up to multimillion-dollar corporations. Clients rely on Leigh's experience and counsel to structure their tax matters, which can range from a few million to over $100 million. Leigh is also a sought-after seminar leader and has a featured column in Taxes Magazine as the Passthrough Partner, published bi-monthly by CCH Tax and Accounting. His background as a certified public account has contributed to groundbreaking legal work, including: Creation of the first LLC in Tennessee, development of the Double Holdco LLC structure for the home healthcare industry, being named principal draftsman of the Tennessee LLC Act, and participating in the first insurance annuity combination securitization. Leigh is the sole Tennessee Fellow of the American College of Tax Counsel and Chair of LLC and LLP Subcommittee of the Partnership Committee of ABA Tax Section. Page 76 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    78. 78. Contact Information W. James Lloyd, CPA/ABV, ASA, CFE Principal, Pershing Yoakley & Associates, P.C. (865) 673-0844 jlloyd@pyapc.com J. Leigh Griffith, JD, LLM, CPA Partner, Waller Lansden Dortch & Davis, LLP (615) 244-6380 leigh.griffith@wallerlaw.com 11186477 Page 77 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY
    79. 79. 1 Unique Benefits of Treating Personal Goodwill as Property in Corporate Acquisitions, Delaware Journal of Corporate Law, Vol. 30, Darian M. Ibrahim. (Footnote cut from Slide 64 Now renumbered) 1 Unique Benefits of Treating Personal Goodwill as Property in Corporate Acquisitions, Delaware Journal of Corporate Law, Vol. 30, Darian M. Ibrahim. (Footnote cut from Slide 67 Now renumbered) Page 78 ATLANTA | KANSAS CITY | KNOXVILLE | TAMPA BAY

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