If a partner decides to leave a medical practice, it’s important to have a tax allocation approach in place and ready to be implemented. In nearly all cases, there are three different methods you can use:
- The interim closing of the books method
- The proration method
- An agreed-upon, reasonable method
Of course, before making any concrete decisions about the best method for your situation, it’s always wise to speak with a certified accountant so you can be sure you’re making the right choice.
Interim Closing of the Books
Using the interim closing of the books method, the partnership closes its books on the date of exit. From there, the partners total all tax items from the beginning of the year up until that date, and the exiting partner’s allocation is based on their preexisting percentage.
Following the closing of the books, the departing partner will not have any affiliation with any financial occurrences that happen after that date — whether paying or receiving.
For example, if the partner left halfway through the calendar year and the practice decided to sell its office space at the end of the year, the partner who left would not receive any shares of that capital gain. Likewise, if the practice received a tax penalty after the books have been closed, the partner would have no liability to contribute in paying.
Using this method, the exiting partner’s share of tax items are prorated based on his or her share of profits and losses and the duration of the partnership during that year. In some instances, this method is straightforward, but it can also be quite complex, requiring assistance from a CPA.
Here is an example: if a partner who owned a 50-percent share of profits and losses left halfway through the calendar year, they would be allocated 25 percent of the year’s tax items, as 50 percent (profits and losses share) of 50 percent (of the calendar year) equals 25 percent.
When using proration tax allocation, the partner who has already left can still benefit from sales of business assets (such as office space) and can be required to take a hit if assets depreciate. That’s why the proration method isn’t always the most accurate reflection of the practice’s current financial situation.
An Alternative, Reasonable Method
In some cases, the best approach is to compartmentalize tax items according to specific, unique events that only happen once. In this type of situation, all parties must agree to the terms.
This approach is often used in case a major financial change occurs that would force the exiting partner to receive or pay money even though they already left the practice.
Using that same example of the medical practice selling its office space at the end of the year after the exiting partner has already departed, the main allocation of taxes could be based on the proration method, with the exception being that the exiting partner doesn’t share in profits from the sale of the office space.
Contact Maxwell Locke & Ritter for Expert Guidance
We encourage you to call (512) 370-3200 or message us online now for expert assistance in selecting the right tax allocation method for your practice. Whether you’re establishing guidelines early or dealing with an exiting partner now, our skilled team is ready to help you make an informed decision.