This message is for dental practice buyers. Be on the lookout for Covid related income disguised as patient income or reduced overhead.

We’ve been seeing this since early to mid-2021, and we continue to see it. As we’re doing our due diligence for our buyers, we’re uncovering issues of how Covid income was reported on practice financials which should have been removed or adjusted out for cash flow analysis.

So, what is Covid income? Covid income is simply income or benefits that the practice received due to the various Covid relief funds made available to dental practices to help them recover from shutdowns and payment of employee wages during Covid.

Buyers need to look for this income and ask the right questions to make sure this income is accounted for in the analysis of the practice price and performance. If it goes unnoticed and unaccounted for, the result could be a couple of years of higher practice income and\or reduced overhead that makes the practice look much more profitable than it really is. This leads to overpriced practice!

For the most part, this income and\or benefits have been adequately reported by the practices and accounted for within a seller’s financials that they (or sellers’ advisors) present to prospective buyers. However, we have found situations where proper reporting wasn’t adhered to, and adequately reported benefits haven’t been disclosed or even known by sellers and their selling advisors. I’ll review some examples of situations we have seen and uncovered for some of our buyers.

– The first area is usually the easiest to identify and, as noted above, generally gets reported correctly by sellers and their selling advisors because it is tax-free income. I’m talking about the PPP loans. Practices could have had PPP “income” in 2020 and 2021, and if the seller and their advisors didn’t appropriately report it, it could make those two years look incredibly profitable. In some cases, we have discovered that this “income” was added to practice collections, along with all other patient collections, and an unsuspecting buyer may not know to ask about this.

– The next area is with the HHS funds; that’s how we identify it anyway. Some practices applied for and received Covid related HHS monies to help cover covid related expenses. These reimbursements could have ranged anywhere from $10k to $100k+, and this “income” IS taxable. Therefore, it didn’t necessarily need special reporting on an income tax return. Therefore, if this income was added to patient collections, an unsuspecting buyer might not realize that the groups used to determine price are inflated. It could have also been reported as a reduction in the various expense categories like repairs & maintenance, office supplies, or dental supplies. Buyers need to ask about this income if they don’t see it separately reported.

– The following two areas are related to wage tax credits. By now, most people have heard the term ERC, or Employee Retention Tax Credit. The other wage tax credit was available under the FFCRA “act.” These were wage-based tax credits that employers could apply for and receive based on specific criteria they had to meet. Unfortunately, the “income” from these tax credits is somewhat hidden even though it’s been appropriately reported. Let me explain. The ERC tax credit is reported as a REDUCTION to wage expense in the year the credit was taken. So, you could have a practice with $100,000 in actual wages paid with an ERC benefit of $25,000. When you look at the tax return and\or financials for this practice, wages will show as $75,000. This is proper reporting for the ERC tax credit. Unless the buyer knows to ask about this, practice wage expense and total overhead expense could be unusually low for 2020 and 2021, which makes the practice look more profitable. We’ve seen very few seller financials and the corresponding analysis to determine the price account for this Covid income. The FFCRA tax credit could have been handled in a similar way. It’s also possible that this benefit was incorrectly reported when it was received in 2022 or 2023.

– Finally, many states provided their own Covid relief to businesses through grants, expense reimbursements, and loans that were “forgiven.” Unless they were reported separately within the seller’s financial statements and\or tax returns, we wonder how many seller advisors are asking about this income and trying to separate it from the patient revenue when doing their asking price analysis.

Now, I’m not suggesting that sellers and their selling advisors are doing anything intentionally. I believe many selling advisors don’t know how to ask the questions themselves or have asked the questions. The sellers replied that they didn’t receive any other Covid income without knowing what it meant.

It is up to the buyer to do their due diligence and ask these questions to ensure they get satisfactory answers. This will continue to be something buyers will need to ask about as long as they get seller financials for 2020 and 2021. Once we get past 2021, we should be in the clear; not so! I suspect there will be CPAs and accountants of sellers reporting ERC refunds in the year the refunds were received, in 2022 or even 2023. Again, I don’t think it’s intentional, just not proper reporting. Therefore, buyers will need to ask these questions well into 2025 and even 2026 if they include 2022 and 2023 financials in their analysis.

Buyer Beware!