Be Prepared: Healthcare M&A Going Strong With No End in Sight
By Michele Lipson, Partner, Tax & Business Services & Nicholas Scher, Senior Accountant, Tax & Business Services
The first nine months of 2021 saw an all-time high of approximately $2.2 trillion in mergers and acquisitions (M&A) across the Americas — more than the full-year totals in 2018, 2019, and 2020. A lot of the success in 2021 can be chalked up to COVID recovery, millions in fiscal stimulus, widespread popularity of special purpose acquisition companies (SPACs), a trillion-dollar private equity war chest, and more. This year is shaping up to be another banner year for M&A activity.
Midcap healthcare companies drove much of the M&A activity in 2021 with the goal of boosting top-line growth, adding products and practice areas to their portfolios, and creating industry-wide synergy that should ultimately lower costs for consumers. Overall, healthcare M&A volume was up 16% in 2021, and deal value rose 44% to $440 billion from 2020 across virtually all sectors, according to a report issued by Bain & Company earlier this year.
The historic healthcare M&A activity in 2021 was made possible through strategic and thorough financial and tax due diligence, which is a critical step before buying or selling any business — and the purchase or sale of a medical practice is no exception.
Regardless of whether a deal is structured as an equity or asset transaction, buyers should be concerned with successor liability (i.e., whether they will inherit and be on the hook for any of the seller’s potential income or non-income tax exposures). Whether a buyer inherits the past income and non-income tax history of a medical practice depends on the structure of the deal. Generally, the practice’s income tax history carries over in an equity sale (both for corporations and pass-through entities), but not in an asset sale.
To minimize any risk related to successor liability, the scope of a tax due diligence engagement should include, but not be limited to, a review of the medical practice’s federal income tax returns, fixed asset and intangible assets (and the extent of depreciation and amortization taken on those assets), consulting and non-compete agreements, goodwill considerations, and state and local income and non-income taxes, such as sales, use, payroll, and property taxes.
Structuring the Sale
Because the seller typically wants to sell equity to receive capital gains tax treatment, and the buyer wants to buy assets for the depreciation and amortization tax benefits from the step-up in basis, there is much to consider and negotiate when structuring the deal. However, maximizing federal income tax benefits is only part of the battle. Compensation and transaction cost planning also need to be considered, and ultimately affect EBITDA and the purchase price.
The buyer almost always ends up issuing personal payments to the seller’s doctors, nurses, and employees after closing — usually in the form of consulting or non-compete payments. While these payments may provide tax benefits, they can also give rise to income and payroll tax exposures.
For example, all consulting payments made to a doctor to stay on as a consultant for the buyer must be considered reasonable under IRC Section 162. What is reasonable depends on a factor-based test that is analyzed with current facts and circumstances in mind. There are also tax benefits related to how these payments are characterized (i.e., Ordinary, IRC Section 197, etc.) that must be considered.
Issues can also arise when providers pay physicians via a 1099 arrangement rather than W-2 income. While there are advantages, such as decreased payroll taxes, workers’ compensation coverage, and malpractice insurance, this business model may trigger concern over employment tax during the diligence phase. For example, if a medical practice repeatedly utilizes a specific physician year after year, and pays them via Form 1099, there may be a risk on audit that the IRS and/or a state revenue agency may determine the physician is actually an employee, leaving the buyer on the hook for unpaid employment taxes.
These payments should be addressed when negotiating the purchase price.
State and Local Tax Implications
Like with federal income taxes, the buyer does not generally inherit the company’s state income tax history (including past state income tax liabilities) when purchasing business assets, but it does inherit those liabilities when purchasing equity. However, buyers and sellers may face concerns over entity-level taxes, gross receipts taxes, sales and use taxes, employment taxes, and more, which should not be overlooked.
States may also impose successor liability for sales and use taxes regardless of the form. Most people in the healthcare industry assume medical-related services and medical-related purchases are exempt from sales tax. However, not all states allow the same exemptions. For example, if a medical group has practices in multiple states, the purchase of medical equipment or the sale of over-the-counter medications may be exempt from sales tax in one state but not in the other, resulting in unpaid sales or use tax exposures.
As healthcare M&A activity continues, many physician practice leaders will contemplate a transaction after hearing success stories from friends or being approached by buyers unexpectedly. Preparing for these conversations regardless of whether you are actively considering a sale is a worthwhile exercise. Having the right team of professionals within reach can help you navigate this process in a way that maximizes the value of your years spent caring for patients and building a successful practice.
Marcum’s healthcare industry professionals include experienced M&A transaction advisory team members who understand the intricacies of provider practices and related healthcare businesses. We’re here and ready to assist with proactive planning to create successful and smooth transactions.