More than 5 million businesses took advantage of the forgivable Paycheck Protection Program loans that were part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Recent changes to the program could have tax implications. Here's what small business owners who received a PPP loan need to know before filing their 2020 taxes.
What was promised in the Paycheck Protection Program?
In the wake of widespread lockdowns, many small businesses experienced greatly reduced patronage, dwindling revenues and, in many cases, potentially permanent closure. In a bid to counter those issues, Congress passed the CARES Act as a multipronged stimulus package that included loans for distressed industries, an expansion of unemployment benefits, and billions in emergency grants.
The other major aspect of the CARES Act that sought to help entrepreneurs was the $350 billion set aside for small business loans from the Small Business Administration. Through Congress' action, the PPP attempted to help small businesses cover their payroll costs and keep people employed through the pandemic by providing up to 2.5 times their monthly payroll expenses, with a hard cap of $10 million per loan.
These are some qualifying expenses for forgiven PPP loan proceeds:
- At least 60% of the loan, up to $100,000 per employee, used for payroll
- Employees paid at their regular levels throughout the eight or 24 weeks of the loan
- The continuation of healthcare benefits
- State and local compensation taxes
- Other business costs, such as rent, mortgage interest and utilities
Though the initial batch of PPP loan proceeds quickly dried up, the PPP served as a life raft for many small businesses. Last month, the SBA announced that another run of PPP funding would begin with the new year. With $284 billion set aside for this latest iteration of the PPP, the program is set to provide up to $2 million per loan to help each PPP borrower. This time around, applicants were limited to businesses with 300 or fewer employees that could demonstrate at least a 25% reduction in quarterly year-over-year revenue.
These are some additional business expenses forgiven through the latest round of PPP:
- Software
- Personal protective equipment (PPE)
- Property damages
How does the PPP affect taxes?
While the idea of receiving funding from the government with no expectation of paying it back was a balm for small business owners, one area of confusion has been its potential impact on taxes. Since the loans would be forgiven, questions remained as to whether the forgiven amount would be considered taxable income and whether expenses covered by the loan could be deducted. Though the PPP was seen as a lifeline, many experts warned that the original legislation could be a tax-laden time bomb.
That confusion came to a head last May when the IRS issued Notice 2020-32, which stated that if forgiven PPP loans were not taxable, expenses that would be considered a tax deduction in a normal year, such as rent and utilities, would not be deductible in the 2020 tax year.
The announcement effectively kneecapped one of the most attractive parts of the PPP. When Congress passed the latest round of PPP funding through the Coronavirus Response and Relief Supplemental Appropriations Act (CRRSAA), it reversed the IRS' decision by declaring that a forgiven PPP loan would be tax-exempt income. Thanks to that clarification from Congress, businesses can get a PPP loan and still get the employee retention tax credit (ERTC) for tax years 2020 and 2021.
What should you consider now?
Though Congress has walked back the IRS' stance on the PPP and its relation to deductible income, that doesn't necessarily mean you can leave those funds out of the conversation on your 2020 taxes. Rafael Alvarez, founder and CEO of ATAX, believes that whether you received PPP funding in its first iteration or later on in 2020, you should still be careful when it comes to taxes.
"There are still a lot of unanswered questions," Alvarez said. "What about the expenses that the business owner paid with the PPP? If the income is entirely tax-exempt, are the expenses nonreportable? There are a lot of issues."
Some of those issues, he said, stem from confusion in the PPP application process. In some cases, application woes meant businesses received money that they weren't qualified for in the first place. For instance, a company might have stated that it had employees when it only had independent contractors. While that may seem like a case of semantics to the layperson, that kind of difference could have major implications when it comes time to file business taxes. How those funds were used is also important to keep in mind.
"Any money that the business owner used to pay something else that is not included in the PPP requirements, they will have to report the amount as income and expenses in their business tax return," Alvarez said.
Be careful with tax credits.
One area that could be impacted by the PPP is the ERTC. Though businesses that get the PPP can still obtain the ERTC, how much of a credit you receive could be altered as a result, said Jackie Meyer, a certified public accountant and the president and founder of Meyer Tax Consulting.
"The PPP loan forgiveness payroll calculations affect the calculations for the employee retention credit," she said. "You can't utilize the same payroll expenses in both calculations – they have to be different."
Meyer also pointed out that if a business takes the ERTC in addition to the forgiven loan, it's no longer allowed to take the work opportunity tax credit (WOTC).
See if your state considers your PPP loan taxable income.
Though PPP loans are fully tax-exempt at the federal level, make sure to check your state's stance on the matter. Though a number of states have taken steps to follow federal guidelines, your state and local taxes may be impacted.
According to the SBA, 21 states and Washington, D.C., are "rolling conformity states, meaning they automatically conform to the most current Internal Revenue Code (IRC) for both individual and corporate income taxes."
Some states – such as New Jersey, Mississippi and Arkansas – have selective income tax conformity, so you'll have to check your local guidelines if you operate in one of these states. Massachusetts and Pennsylvania offer rolling conformity to corporate income taxes, though Massachusetts has static conformity and Pennsylvania has selective conformity for individual income taxes.