Paycheck Protection Program (PPP) loans provided a much-needed boost of working capital to businesses that were struggling amid the coronavirus. While the PPP loan helps cover payroll and utilities, these loans are forgivable, but from a federal tax perspective, they don’t work like other forgivable loans. Is your PPP loan taxable? Here is what you need to know.
Are PPP Loans Taxable Income?
PPP loans are not taxable income. If your business received a PPP loan, you do not have to report the funds as revenue. This rule is fairly standard. Generally, when you take out a business loan, the funds are not considered to be part of your business income.
Normally, the Internal Revenue Service (IRS) requires you to report forgiven loans as income, and this rule applies to both individuals and businesses. However, with the PPP loans, this standard does not apply. Even if the government forgives your PPP loan, the funds are still not classed as business income from a Federal perspective.
Here is how reporting loans as income works normally. Imagine you receive a $100,000 loan for your business. You do not have to report the funds as income. But if the lender forgives the loan, you do have to report the $100,000 as income. Similarly, if you’re an individual and a creditor settles your $10,000 credit card debt for $4,000, you have to report the canceled debt of $6,000 as income.
Again, with PPP loans, you do not have to report the amount you received as income. Whether the SBA forgives the PPP loan or a part of it or not, it is currently not considered part of your taxable business income.
Are Expenses Paid With PPP Loans Deductible?
Expenses paid with PPP loans are not deductible. If you wrote payroll checks or paid utility bills with the funds from your PPP loan, you cannot deduct those expenses on your tax return.
Again, this is also not a new rule. Based on section 265 of the tax code, taxpayers generally cannot take deductions tied to tax-exempt income.
That said, there are exceptions to this rule for individuals. Namely, religious leaders and military service people have been allowed to claim tax deductions for mortgage interest and property taxes even if they were paying those bills with tax-exempt housing allowances.
Due to this exception, some analysts think the IRS may revise its ruling, but at the time of writing, these expenses are not deductible.
Will Not Claiming Deductions for PPP Expenses Hurt Businesses?
When the IRS issued guidance about PPP loans and deductions at the end of April, some business owners interpreted the news as distressing, and several analysts claimed this would increase expenses for business owners.
But ultimately, business owners should not face any extra tax liability due to this rule. If PPP loans are not taxable income and expenses covered by these loans are not deductible, the numbers simply cancel each other out.
To give you a rough example, say your business received a $200,000 PPP loan, and you used the funds to cover $200,000 in payroll and utilities. The loan is forgiven, and you don’t have to pay it back. You can’t claim a deduction for the payroll checks you wrote or the utilities you paid, but you also don’t have to report the $200,000 as revenue. As a result, the funds are a wash.
Now let’s say that besides the loan, you collected $500,000 in revenue, and you spent $300,000 in qualifying business expenses (not counting the expenses you covered with your PPP loan). At this point, you have $200,000 in business profits. Your PPP loan taxability does not affect this number.
Are Expenses Paid With Non-Forgiven PPP Loans Deductible?
The government only plans to forgive PPP loans if the funds are used as intended within a certain time frame after the business receives the money. So, what happens if the PPP loan is not forgiven?
If your PPP loan is not forgiven, you still do not have to count the funds received from the loan as income. But in this situation, you can claim the expenses you covered as deductible as long as they are reasonable expenses incurred while operating your business.
To continue with the above example, say that you took out a $200,000 PPP loan and spent $200,000 on business expenses, but for some reason, you didn’t meet the criteria to have the loan forgiven. If this happens, you can claim a business deduction for $200,000, helping to reduce your business income and lower your tax liability. You can also write off the interest incurred on the loan as a business expense. Again, you don’t have to report the loan as income, but of course, you will need to pay it back.
What Should You Do?
If you’ve taken out a PPP loan, you probably already know about the importance of keeping detailed records about how you spend the funds. These records are essential if you want the loan to be forgiven. However, in the rare case that the loan is not forgiven, these records can help you figure out your business deductions.
Note that issues are changing rapidly, and the IRS may shift its guidance. Furthermore, states have to issue guidance as well. In other words, some states could view a forgiven PPP loan as taxable income. To ensure you have the most up to date info, consult with a tax advisor. If you have tax debt, we can help. Call us today to talk about your options and learn how to get back into good standing with the IRS or state.