So you received a PPP loan to help get you through these challenging times. But did you stop to think if your PPP loan is taxable income?
This article will help you understand how your forgiven PPP loan is taxed and provide clarity on tax implications related to how you spend the money.
How the PPP loan affects taxes
The Paycheck Protection Program (PPP) is a lifeline for businesses who are currently struggling due to COVID-19. The PPP is a loan intended to provide cash flow help for eight weeks, backed by the SBA.
The draw to the PPP loan for business owners is the potential that the PPP loan amount can be forgiven, as long the money was spent on qualified expenses such as payroll, mortgage interest, utilities, and rent (with the majority spent on payroll).
But with this program came a question about how the IRS will view the money. If you meet the criteria for getting the loan forgiven, will the government tax you on the free PPP loan money you’re receiving?
Not directly, but it’s a little more complicated than that.
Will I be taxed for my forgiven PPP loan?
The CARES Act spells out that the forgiven loan amount won’t be included in taxable income. That means you don’t pay taxes on the money that you receive. The aim of this loan is to provide businesses with the money to keep running and continue paying employees, not to create a tax burden for businesses receiving the funds.
But, there’s a catch. The IRS later released a notice clarifying how the forgiven loan amount would be treated when it comes to 2020 taxes:
“This notice clarifies that no deduction is allowed under the Internal Revenue Code (Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), and the income associated with the forgiveness is excluded from gross income for purposes of the Code pursuant to section 1106(i) of the CARES Act.”
Simply put, if the forgiven loan isn’t included in a business’s taxable income, the expenses paid for with the forgiven loan aren’t able to be included as a tax deduction. That may sound like a small detail, but it can potentially have a big impact on your final tax bill at the end of the year.
How will my forgiven PPP loan impact my tax return?
Normally if a business has rent, payroll, mortgage interest, or utility expenses, these are deductible from taxable income. That deduction reduces your taxable income. Without that deduction, you’d owe the government more in taxes.
And that’s what is going to happen in this situation: you lose out on some tax deductions, so you may have to pay more when it comes time to file your taxes.
For example, let’s say your business is a C corp that received $200,000 in a PPP loan. You used that money entirely on payroll expenses and qualified for loan forgiveness. The $200,000 that you receive won’t be included in taxable income at the end of the year.
But you won’t get a $200,000 tax deduction for the expenses you incurred. That means you could have an extra $42,000 tax liability at the end of the year ($200,000 * 21% corporate tax rate) that you wouldn’t have if you were allowed to take the deductions as normal.
While the PPP did provide you with an extra $200,000, you’re losing $42,000 in tax deductions that you’d normally get. In this example, you’re still going to have a net benefit of $158,000 from the program—money that you probably wouldn’t have otherwise. But for some business owners, this could be a big tax surprise that could be waiting for you at the end of the year from a program that is supposed to help your business stay afloat.
PPP loan taxability could still change
While this is a frustrating (and expensive) update to the loan program, it may not be the final decision. Rules are still being written and plenty of people are unhappy that the IRS has taken a position that would negatively impact businesses that are struggling.
The American Institute of Certified Public Accountants (AICPA) is challenging the IRS decision that these expenses aren’t deductible, saying that this goes against Congress’s intent when they created the PPP.
The recent stimulus proposal, the HEROES Act, reverses the decision that these expenses can’t be deductible. While the HEROES Act is still just a proposal and hasn’t been signed into law, it’s clear that some lawmakers want to change the tax treatment of forgiven PPP loans.
There is a chance things could change in the future, but for now, it’s a good idea to assume that you won’t be able to deduct these expenses and you may have a higher tax bill as a result.