PPP Loan and Your Tax Obligations

If like many business owners across the U.S. you relied on a loan from the Paycheck Protection Program to keep your business afloat during the COVID-19 pandemic, you were certainly glad to have this financial assistance. However, when the time comes for you to file your taxes, you may have many questions as to your tax obligation regarding your loan.  Since most tax issues are quite complex, the PPP loan only makes things a bit more muddled and confusing.  To make sure you have a good understanding of your state and federal tax obligation for your PPP loan, here’s what you need to know.

Your Loan Doesn’t Count as Income

Up until the COVID-19 pandemic hit, any business loan that was forgiven was considered to be taxable income, based on the IRS Tax Code. However, that’s not the case with your PPP loan. When Congress passed the CARES Act, it specified that PPP loans will not count as income, meaning the amount of money you received is not taxable. This applies to any type of PPP loan, whether you had the entire amount forgiven or just a portion of the loan.

Expenses Can be Deducted

While the issue of your loan not counting as taxable income was set from the beginning, deduction of expenses has been a work in progress. Initially, the IRS stated that any expenses paid with PPP loans could not be deducted if the loan was to be forgiven. However, that has changed. Instead, the IRS is allowing PPP loan recipients to deduct any expenses that were paid with PPP money. By allowing this, it can have a substantial effect on your state and federal taxes, since more deductions usually mean far fewer taxes to pay.

Beware of Business Taxes

Even though you have quite a bit of flexibility as a business owner regarding how your PPP funds can be spent, be aware of how this applies to your business taxes. While such things as business software, property damage, and protective equipment are expenses that can be covered with PPP money, business taxes are not. Thus, should you use any of your PPP loan to pay business taxes, the amount you pay will not be forgiven.

Some States are More Forgiving Than Others

When filing your federal taxes, you may find plenty of forgiveness to go around. Unfortunately, the same may not apply to your state taxes.  Since states can vary their approach as to how they abide by the federal tax code, each one can in effect make up their own rules to a certain extent. Thus, while one state may decide to not count PPP loans as taxable income, another may not. The same holds true with expenses that can be deducted, meaning you may find yourself owing far more in state taxes than federal taxes. Needless to say, you’ll need the advice of a trusted and experienced CPA to sort through what your state is doing in this area.

Rolling and Static Conformity

As to why there are so many variations among states, you can blame rolling and static conformity. When a state holds to rolling conformity, this means it automatically adopts any new federal tax changes once they are implemented. However, for states that use static conformity, they base their tax decisions on the rules contained in the federal tax code as of a certain date. Thus, to accept any changes made beyond that date that may benefit you the taxpayer, the state must pass legislation.

To make matters even more confusing, it is not uncommon for states to cherry-pick parts of the tax code to their liking. As a result, a state that generally uses rolling conformity rules may use static conformity in some areas, and vice versa.

Why This Matters

If you are wondering why the decisions of states matter so much in the PPP loan mix, it can come down to how much taxable income you are viewed as having when filing your taxes. For example, if your state chooses to deny you the chance to deduct expenses paid with your PPP loan, the result is that your taxable income will likely be increased to an amount that would be more than you would have had if you had not taken out a PPP loan in the first place. Thus, since your business has already been struggling to stay afloat financially, this tax impact could have severe and long-lasting consequences you never anticipated.

Employee Retention Tax Credit

If there is one good thing that has arisen for many business owners who received PPP loans, it is that most are still eligible to claim the Employee Retention Tax Credit. However, you won’t be able to claim wages that were paid with your forgiven PPP loan. Instead, you can claim the credit for any wages that were paid above and beyond the amount of your loan that was forgiven. To qualify, you must be able to prove you suffered at least a 20% drop in your gross receipts from the same period one year ago.

An Audit is Still Possible

Remember that just because the federal government was kind enough to give you the money needed to keep you in business doesn’t mean the IRS won’t come calling with an audit of your tax returns. Since there are so many new additions and requirements regarding PPP loans, you’ll need to be extra vigilant with your record keeping. In fact, the lender that gave you the PPP loan as well as the SBA have the authority to audit your company’s financial statements and related records for up to six years after your loan was forgiven, so be aware of this when filing your federal and state taxes.

As you know, preparing and filing taxes is difficult enough in normal years, much less the ones that have been pandemic-ridden. Rather than make a costly mistake, consult with your trusted and experienced CPA to ensure you know the rules and how they apply to your situation.