Sorting through your clients’ financial statements and tax returns can easily leave you scratching your head. Not only are they complicated, but they can also be inconsistent from client to client. This year is no exception: thanks to a tax law change and a certain pandemic-relief measure, your clients’ 2021 financials could deviate from what you’ve seen in years past. Here’s what you should know.
Expect to see an increased state tax for pass-through entities (PTE) tax
Thanks to Minnesota’s new pass-through entity tax, you’re likely to see a higher state tax amount on the tax return and possibly financial statements of S corporations and partnerships than in previous years. The tax serves as a state and local tax (SALT) “workaround” for the $10,000 tax deduction cap on the Schedule A—meaning it allows the entity to pay the owner’s Minnesota tax and deduct it as a business expense.
What you should know:
- Guidance for Generally Accepted Accounting Principles (GAAP) financials is unclear.
- Some firms are showing PTE as a distribution (as they have in the past for composite or nonresident withholding). The reasoning is that it is a tax paid on behalf of the taxpayer.
- Others are showing it as a business expense. The reasoning for this position is that once the company elects to be taxed in this manner, it becomes a legal business obligation and expense of the company. At JAK, we are presenting it on the face of the income statement under other income and expense section and listing it as a separate line item “state pass-through tax expense.”
- Tax-related items:
- On the tax return, the expense you will see is based on the actual amount they paid in (cash basis).
- Since this law went into effect in late 2021, you may see some overlap with tax distributions for individual state estimates through September. (The entity will now also pay the tax as a business expense, but the catch is that the entity needs to pay 100% of the tax by March 15 for the year. This means that a state refund at the individual level is likely.)
You can expect to see this tax expense on the return and possibly financials of pass-through entities in the years to come. However, you may see a drop in tax distributions, as state taxes may no longer be paid by the business owners.
We anticipate the Financial Accounting Standards Board (FASB) will be issuing guidance for GAAP financial statements in the upcoming year. We also anticipate more states will enact a PTE tax and the existing states will continue to tweak the tax rules for their PTE calculations.
Don’t miss employee retention credit (ERC) dollars
Lots of companies qualified for the ERC in 2021 which translates to up to $21,000 per employee ($7,000 for 3 quarters). The IRS recommends the amounts are netted within payroll expenses; however, on GAAP financials, they will show up as “other income.” If you’re working off a client’s 2021 tax returns, keep in mind there could be ERC dollars hiding in the numbers—meaning the company could appear in better financial shape than it is.
Ask your clients if they received an ERC. If not, make sure they looked into their ability to qualify for the credit. If they did receive ERC dollars and you want support for your file, ask for their payroll tax returns (both originally filed and amended 941s). You will see the credit amounts on their 941s as well as any COVID sick pay they claimed.
You may also see some larger receivables on the financials of clients who applied for the ERC by amending their 941 return and requesting the refund as a check (instead of applying it to the next quarter’s payroll taxes).
Unfortunately, we are expecting a 6–12 month—and potentially longer—wait for these checks to show up, as the IRS is slow to open and process mail. So, you might see an asset on your clients’ financials that isn’t turned around as quickly as one might hope.
Here’s a value-add to offer your clients:
The ERC is taxable for federal but not for Minnesota. If you know a client received an ERC, make sure there is a modification for it on their Minnesota return. Here’s what that would look like for various entities:
We’re here as a tax resource.
If you run into questions while reviewing your customers’ 2021 financials, we’re here to be your resource. We can even help you answer the questions your customers have for you. Contact us today to learn more.