Why prepare a compensation study for a dental practice owner?

The reasons for a study are varied and can be used, as an example, for an estate plan, an insurance study, a divorce, employment agreement, partnership or shareholder agreement and other important considerations. The reason for the answer to the question is similar to what the intent is for a dental practice valuation, in that it must be considered before replying. What is the objective for the question? How is compensation defined for the owner of the dental practice based upon its purpose in the study? How do definitions differ and which one is correct?

Definitions of dental practice owner’s compensation

Here are some types of compensation that are correct in their basic format. They may or may not be the proper explanation based upon the objective of the question. There are many classifications of compensation. One is commonly referred to as deferred compensation, which is a form of remuneration that takes place at a later date than when earned. Employer sponsored qualified retirement plans are an example. Employer non-qualified deferred compensation plans are another. Non- taxable benefits are awarded to owners as incentives to create a higher value and more income for the dental practice and to reduce current taxable income. Another type of remittance is non-deferred payroll, which takes place immediately as salary, bonus or other taxable direct or indirect payment. Taxes are calculated as payment is made, and the owner receives a net check after all deductions are taken from the gross amount.

Definitions and terminations of certain compensation

Sometimes owners of a dental practices put themselves in difficult situations since employees come to expect certain compensation such as employer-sponsored qualified retirement plans and non-taxable fringe benefits. Even though the owner of the dental practice receives these benefits as well as the rest of the employees, it becomes difficult to terminate a deferred compensation plan or a non-taxable benefit plan because of employee morale and discrimination testing, among other reasons. This is especially difficult if the plan(s) have been in effect for some time. If the dental practice is experiencing difficulties with cash flow, the owner can’t arbitrarily terminate a plan because of employee considerations and subsequent potential employee defections to other dental practices. That would then decrease the value of the practice and further reduce cash flow. Because of non- discrimination testing, owners may wish to cease these types of benefits and they can’t. The owner’s compensation reflects greatly on the value of the dental practice and, if it is reduced, the resultant decrease in value of the dental practice is almost assuredly going to take place.

Other aspects of owner compensation

Certain advisors suggest the depreciation that may pass through to an owner’s personal tax return from the dental practice is part of compensation in that it reduces the non-deferred taxable income of the dentist on a current basis. Equipment purchased that created the flow through of the depreciation to the owner’s personal tax return is merely a form of a reserve for the replacement of that equipment. The reduced tax for the owner is supposed to generate the money in the form of tax savings that the owner is prepared to invest back into the practice when the equipment deteriorates and replacement items are needed. The base definition of depreciation and the method used for it is a format where the wearing out of the equipment is creating a “fund.” This reserve should be available for the purpose of acquiring new equipment when the depreciated equipment has lessened in its ability to function at its former high level.

Restrictions in compensation awards

Non-compete agreements with an owner and his or her dental practice are a form of retention handcuffs that keep an owner at the practice. The concept is that the non-compete agreement enhances the value of the dental practice but not necessarily the current compensation of the owner. These agreements are a vital part of increasing the dental practice value. The trade-off of the lesser compensation is more than compensated for with the increased practice value. It is also extremely rare that a buyer would be found without the non-compete agreement executed by a seller.

Are there absolute definitions?

It is understandable after one reads this article, that there are no absolute definitions for compensation. The purpose of the question is the determinant of remuneration for the owner.