Break down the tax implications of Paycheck Protection Program loans
The approaching tax season raises new questions for business owners who have received a loan under the Paycheck Protection Program.
Can you deduct expenses paid with your loan funds? Do you need to do something different this year? And if your loan is canceled, is it considered taxable income?
The answers to these questions have been difficult to pin down, in part because of the changing directions of the IRS. But new rules set out in the latest coronavirus relief round are helping end the confusion.
“Doing your taxes wasn’t easy before COVID,” says Keith Hall, president and CEO of the National Association for the Self-Employed. “The good news is, this year won’t be any more difficult than the tax returns you’ve had in the past. “
PPP LOANS GIVEN ARE NOT TAXABLE
“Historically and forever, if you have a business loan and it’s canceled, it’s automatically taxable income. It’s been part of the recipe code forever, ”says Hall.
Paycheck Protection Program loans break this code. Congress has clarified, and the IRS has clarified, that canceled PPP loans will not count as income. This applies whether your loan is fully canceled or only part of it.
“If he’s forgiven, it won’t be taxable income. Period, ”says Hall.
YOU CAN DEDUCT THE EXPENSES PAID WITH A PPP LOAN
This one has been more of a moving target. Initially, the IRS position was this: Expenses paid with PPP loan funds cannot be deducted if the loan has been or will be canceled.
However, that changed with the Coronavirus Relief Law enacted on December 27, 2020, which specifies that deductions should not be denied simply due to loan cancellation.
This means that the expenses paid with your P3 loan are deductible.
This result effectively creates two levels of tax benefits for PPP loan recipients, says Roshani Pandey, financial advisor and founder of True Root Financial in San Francisco.
“The first benefit is to make the loan tax-free on income,” Pandey explains. “The second allows businesses to claim deductions on expenses paid.”
CORPORATE TAXES ARE NOT AN AUTHORIZED USE OF PPP FUNDS
The latest round of coronavirus relief also gives business owners more flexibility in how they spend P3 funds. Newly covered costs include protective equipment, hardware damage, and business software.
Business taxes are not included in this extended list. So if you are using your PPP loan to pay your business taxes, this amount will not be waived.
YOU CAN ALWAYS APPLY FOR IMPT CREDIT FOR EMPLOYEE RETENTION
Businesses can now claim the Employee Retention Tax Credit if they meet the requirements. There is an important caveat: you cannot claim wages paid with a canceled P3 loan.
However, you can claim the credit on salaries paid in excess of the amount remitted.
To qualify for the tax credit, you must continue to pay employees despite a temporary shutdown due to COVID-19 restrictions or a 20% drop in gross revenue from the same quarter of the previous year.
These changes were introduced with the Coronavirus Relief Bill on December 27, 2020, but are retroactive to March 12, 2020. Credit is good on eligible wages paid until July 1, 2021.