I will begin purchasing stock from the senior partner in my practice starting in January 2010 as part of a buy-in plan. The way it is set up/proposed is that I essentially sign a promissory note to him agreeing to pay for the stock in 60 monthly payments with a modest amount of interest included. In exchange we will split the profits of the practice equally as income (there is already another partner who owns a 1/3 of the stock of the practice).
I would like to know how I can better structure this arrangement to make it more tax advantageous for me. Otherwise, I am buying the stock with after tax dollars, which, even after earning more in income than I am now, will result in a net reduction of my actual take-home amount next year.
Any suggestions?

Zip Code: 02492

Great question.

For starters, you are correct that you will be buying into the practice with post-tax dollars. The seller, meanwhile, will be reporting the income as capital gains, so will be taxed at a maximum rate of 15% for federal taxes.

Sometimes a portion of these deals are structured with pre-tax dollars. Basically, you sign an employment agreement which periodically allocates a portion of your compensation to the seller. This lets you buy in with pre-tax dollars. One issue is that the seller is now taxed on this income as ordinary income, with a top rate of 35%, instead of as capital gains with a top rate of 15%.

I've seen this income shift called a few different things. In one deal it was a "Senior Disparity", and in another it was a "Management Fee". Basically, you are saying that the more experienced physician in the group is a little more valuable than the newer doctor, so you are willing to allocate a portion of your annual salary to that physician.

There is another pitfall to this arrangement for the seller. With a post-tax loan, there will be a Note drafted. If you decide to leave the practice, you are still on the hook for the balance of the note. With the pre-tax arrangement, the amount due is specified through an employment contract. If you were to leave the practice, the employment contract terminates, and the seller would have no recourse to require you to pay the remaining balance.

A third pitfall is that the IRS does not endorse pre-tax buy-ins.

One benefit of the post-tax way is that you will have a higher "basis" in your interest in the practice. This will reduce the gain you will realize when you ultimately sell your interest down the road.

My practice is located in Woburn, MA. If you need help determining if you are paying a fair price for your interest in the practice, or have other questions pertaining to this buy in, please give us a call at 781-938-0045.

Zip Code: 01801