2020 was the year of many gifts from our friendly governments, from free money to very generous tax credits. Granted, many dental practices needed those benefits to maintain steady during the horrible year of COVID, and hopefully, many took advantage of the benefits in which they were entitled.
We hope you have already been informed on how practices will need to handle PPP1 loan forgiveness, EIDL grants, HHS reimbursements, not to mention state and local grants and loans. Now we have tax credits that need to be addressed on many 2020 practice financial statements and income tax returns, and I fear that many may not be aware of how these are generally reported.
Let us begin with the tax credits you may have earned under FFCRA when you paid sick and family leave wages to eligible employees. Generally, you claimed those wages paid as you went along in 2020. When your payroll provider completed and filed your quarterly payroll returns, you either saw a decrease in your payroll tax withholdings and/or you received a refund check for any tax credits owed.
Are you aware of how these tax credits should be reported on your income tax returns and how you might want to report them on your financial statements?
For income tax reporting, the general guidance is that the tax credit amount should reduce the operating or capital expense item it relates to. However, the FFCRA tax credit is one of the exceptions you often hear about with general rules.
You see, total wages may be a factor in other aspects of a business income tax return, for dental practices, mainly your QBI deduction. The official guidance that has been issued states that you should treat this as other income on your income tax return. So while the tax credit is a great windfall for many businesses hurting in 2020, there are no free lunches! If your tax credit totaled $20,000, then your taxable income will increase by $20,000, and depending on your entity and\or your income tax bracket, you will be increasing your tax liability by maybe 33% or nearly $7,000. I suspect many practice owners are not aware of this.
For financial statement reporting for 2020, we are suggesting you NOT reduce your wage expense on the financial statements either so that you can continue to have apples-to-apples comparisons between years. Instead, we recommend creating an “other income” category, something like FFCRA Tax Credits, to reflect these credits.
Now we have to deal with the Employee Retention Tax Credit (ERC) that JUST became available in early 2021 for many practices for the 2020 income tax year. As a refresher, when the CARES act was passed back in March 2020, the ERC was NOT available for businesses that accepted and received the PPP1 loan. However, in late December 2020, congress passed another batch of legislation that allowed PPP1 recipients to go back and claim the ERC if they met the 2020 ERC tests. This update presents another twist in reporting. For income tax reporting purposes, this credit follows the general rule, and you should reduce your wages by the amount of the credit until another guidance suggests otherwise. The financial statement reporting will be slightly different since you will be claiming these tax credits after 2020 has already ended.
We suggest that once you have determined the amount of ERC you are entitled to, you will inform your payroll provider so that they can amend your impacted 2020 quarterly payroll returns. Then, you can begin to wrap up your 2020 financial statement by showing the ERC amount you are expecting as a receivable on the balance sheet. The other side of the journal entry will be to an “other income” category, similar to the one for FFCRA, so that you can maintain an apples-to-apples comparison between years for your wage expense.
Unfortunately, I suspect we will see many funky-looking 2020 financial statements and statistics in the immediate future since many practices are doing their own financials and will likely not place much importance on proper reporting for these tax credits. I suspect there will be many improperly prepared income tax returns as well. It will certainly be interesting in late 2021 and into 2022 when we see or hear that a practice wage expenses was only 5% of their collections instead of 25%.
Let us hope and pray that 2021 will be a much better year for all of us, and the tax return season in early 2022 will get back to some form of normalcy.