Tax Traps And Opportunities When Selling Your Medical Practice

Selling a medical practice can be one of the most significant financial events of a physician's career.

While the sale price often grabs the spotlight, it's the after-tax proceeds that truly determine whether the deal is a success. Many practice owners enter negotiations without fully understanding how different deal structures and tax treatments can dramatically affect their bottom line. From purchase price allocation to rollover equity, there are numerous tax pitfalls—and planning opportunities—that can either erode or enhance your net proceeds. Here are the key tax considerations every medical practice owner should evaluate before signing on the dotted line.

Strategy Before Signature

Before signing a Letter of Intent, it's crucial to have a strong team in place and fully understand the deal terms. Good legal and tax advice is essential to ensure the deal aligns with your goals. Changing deal terms after an LOI is signed can be difficult or even impossible, so it's important to get it right from the start to avoid surprises later.

Most physician practice sales are structured as asset sales, not stock sales. Buyers typically prefer asset deals because they can avoid taking on the seller's liabilities and benefit from a step-up in the tax basis of the acquired assets. That said, in some cases, parties may opt for a stock sale to preserve the legal entity, its EIN, contracts, or licenses.

Purchase Price Allocation

When a practice is sold, the buyer and seller should agree on how the purchase price is divided among assets such as goodwill, equipment, and non-compete agreements. This allocation affects how the IRS taxes each part of the sale. Goodwill is generally taxed at favorable long-term capital gains rates, while equipment might be subject to depreciation recapture taxed as ordinary income, and non-compete agreements often taxed as ordinary income. It's important to be proactive in negotiating this allocation and make sure both parties file IRS Form 8594 with the agreed numbers to avoid audit risks.

Earn-Outs: More Than Just a Risk-Reward Play

Earn-outs are payments made after closing based on future practice performance. They can help bridge valuation gaps but add tax complexity. Depending on how they are structured, earn-outs may be treated as part of the sale price (capital gains) or reclassified as compensation or interest (ordinary income). Sometimes the installment sale method can defer tax until payments are received, but this isn't always available. Work with a tax advisor to properly characterize earn-outs and explore deferral options.

Goodwill: Business or Personal

This is an important consideration, especially if your practice is a corporation. Goodwill can be split into business goodwill (owned by the practice) and personal goodwill (tied to your individual reputation and patient relationships). If personal goodwill is properly separated and sold by you personally, the proceeds may be taxed at favorable capital gains rates and can avoid the double taxation that corporations face.

Additionally, when a practice has multiple owners, distinguishing personal goodwill can provide flexibility in how the purchase price is allocated among sellers. Proper planning and clear documentation are needed to make this distinction work.

Rollover Equity: Deferred Tax or Immediate Hit?

In deals backed by private equity, sellers are often asked to roll over part of their proceeds into equity in the buyer's platform. This can be a good way to participate in future growth if structured correctly. Otherwise, the IRS might treat it as a taxable event, triggering immediate capital gains tax without cash in hand. To qualify for tax deferral, the rollover must be structured properly. It's important to understand where your equity is going and your rights post-close.

Capital Gains vs. Ordinary Income: Entity Type Matters

How your proceeds are taxed depends on your practice's entity type. S corporations and partnerships often allow for capital gains treatment on sales, while C corporations face double taxation—first at the corporate level, then again when proceeds are distributed. Asset sales usually trigger different tax treatments by asset type, while stock sales can simplify taxation for sellers but are less common due to buyer concerns. If you recently converted from a C-Corp to an S-corp, be cautious, as the IRS may still tax built-in gains at the corporate level for up to five years after conversion.

Employment & Consulting Agreements: Hidden Tax Drag

Many buyers require sellers to continue working after closing under employment or consulting contracts. While these provide income stability, payments under these agreements are taxed as ordinary income and may be subject to self-employment or payroll taxes. Earn-outs tied to performance under these agreements can also be reclassified as compensation rather than sale proceeds. Separating post-sale services from the sale itself can reduce tax risks.

Don't Forget About State Taxes

State taxes can significantly impact your proceeds, especially in high-tax states. Some states don't follow federal capital gains rates, tax the full sale amount as ordinary income, or create filing complexities if the buyer is out of state. On the positive side, many states have introduced Pass-Through Entity (PTE) taxes, which, depending on deal structure, may allow you to deduct state taxes on your federal return. When available, this deduction can yield significant federal tax savings, making it a key opportunity to consider in deal planning.

Exit Timing: How Timing Affects Your Tax Payments

Most medical practice owners will hit the highest tax bracket on their sale proceeds, so while the tax rate may not change much, when and how you pay those taxes can make a big difference. The timing of your sale can impact your cash flow and overall tax planning.

For example, even if you sell early in the year, you don't always have to pay the full tax bill immediately. You can take advantage of IRS safe harbor rules by making estimated tax payments spread out over the year—or even delay certain payments until the following April. This gives you some breathing room to manage your cash flow after the sale.

You can also use tax strategies like loss harvesting, where you realize losses on other investments before or after the sale to offset gains and reduce your taxable income.

Finally, estate tax planning before the sale is critical. By organizing your estate ahead of time, you can maximize benefits and potentially reduce estate taxes that might otherwise apply to your new wealth.

Post-Sale Planning: What Comes Next

Once your sale closes, your financial planning doesn't stop. There are ongoing tax and wealth management issues to consider, including the potential tax treatment of any earn-outs or rollover equity you might have received.

Beyond taxes, now is the time to focus on protecting and growing your wealth. This includes reviewing your estate plan to align with your new financial situation, implementing asset protection strategies, and working with your financial advisor to diversify investments and generate income.

Engaging your CPA, estate attorney, and financial advisor early helps create a coordinated plan to preserve wealth and support your long-term goals.

Selling a medical practice is about more than just the sale price—it's about understanding how taxes affect your proceeds and structuring the deal to protect your lifetime of work. Early and thoughtful tax planning can help maximize your net proceeds and position you for a successful transition to your next chapter, whether that's retirement, reinvestment, or a new venture.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.