PPP tax implications

The tax rules around the PPP changed several times. There is a new qualification for business owners who want to apply for a second PPP loan: You must show a 25% or greater revenue decrease since the previous year.

image of a ppp loan

The government distributed about $670 billion in Paycheck Protection Program (PPP) loans in 2020 alone.1 The loans were a welcome reprieve for Main Street, but the tax rules around the PPP changed several times.

As the tax deadline looms, what do small business owners need to know about tax implications if they received a PPP loan? This guide will walk you through what you need to know.

What is a PPP loan?

The Coronavirus Aid, Relief, and Economic Security (CARES) Act included the PPP. It was initially a $350 billion package created to give U.S. small businesses eight weeks of cash flow assistance by authorizing 100% federally guaranteed loans. Congress has added to the funds a few times. As of the end of March 2021, the SBA has distributed $734 billion of the $806 billion appropriated so far to small businesses.2

The primary purpose of the PPP is to ensure that workers remain on payroll during the pandemic. The loans are issued by private lenders and backed by the Small Business Administration (SBA). Businesses can select loans issued by an SBA-approved private lender, a credit union, or a fintech company. The SBA’s Lender Match tool assists business owners with finding an approved PPP lender.

The PPP loans are eligible for full or partial forgiveness if the funds are earmarked for costs that meet the program’s criteria. These criteria include payroll, rent, mortgage interest, utilities, worker protection, supplier costs, operations costs, and property damage costs.

How do PPP loans work?

The SBA created a primer for businesses applying for their first PPP loans that explains various companies’ calculations.3

Here’s the math for small businesses: For first-time PPP loans, businesses and nonprofits can apply for a maximum loan amount equal to 2.5 times their average monthly 2019 payroll, or a maximum of $10 million.

  • For example: Your company’s monthly average payroll in the past 12 months was $90,000. $90,000 x 2.5 = $225,000. (This doesn’t include compensation above $100,000 per employee.)

To qualify for a PPP loan, applicants must be small businesses with 500 or fewer employees, including small businesses, S corporations, C corporations, LLCs, private nonprofits, faith-based organizations, tribal groups and veteran groups.

Self-employed individuals, independent contractors, and sole proprietors who file an IRS Schedule C with their Form 1040 are also eligible. However, they derive payroll expenses from their annual gross profit. These individuals can calculate the monthly average payroll expense by dividing annual gross profit by 12. (If the annual gross profit is more than $100,00, you can only claim $100,000 divided by 12.)

  • For example: As a contractor, your gross profit last year was $85,000.. $85,000/ 12 = $7,083.

Can you qualify for a second PPP loan?

In April 2020, Congress authorized an additional $320 billion after the first round of funding was quickly depleted. In December 2020, Congress added $284 billion for new and “second draw” PPP loans for businesses.

There is a new qualification for business owners who want to apply for a second PPP loan in 2021: You must show a 25% or greater revenue decrease since the previous year. You can show this by comparing revenue between any quarter in 2020 with the corresponding quarter in 2019.

For example: A business generated $25,000 of revenue in Q2 2019. It would be eligible for more PPP funding if it had $20,000 of sales revenue or less in Q2 2020.

Once you have successfully obtained a PPP loan, it’s crucial to research the government’s rules about spending these funds. Otherwise, the government may not forgive all or part of the loans, and you will be on the hook to reimburse them.

Can a PPP loan be forgiven?

PPP loans will be forgiven if borrowers only use the funds for designated expenses. A forgiven loan is a grant or free money, so it is vital to understand the details of utilizing PPP loans:

  • Participants are entitled to loan forgiveness for money spent on authorized expenses over 24 weeks after the loan was disbursed (or eight weeks if they so choose).
  • The government may excuse total payments for payroll.
  • Mortgage interest, rent and utilities may also be forgiven, up to 40% of the PPP loan.

There are two considerations to ensure forgiveness of the entire loan:

#1. Small business owners must maintain the pre-pandemic payroll. Employers who fired or furloughed workers have until Dec. 31, 2021, to hire employees back or hire new ones.

If you are a business owner who hasn’t been able to rehire the people you let go, or you cannot find qualified replacements, you can receive an exception for not maintaining headcount. (Exceptions will also be granted if social distancing and other COVID-19-related restrictions cause partial staffing.)

#2. For loans to convert into full grants, employers cannot reduce salaries or wages. If business owners cut salaries, the government will trim the forgiven amount. It will charge an interest rate of 1% on any unforgiven part of the loan, and the remaining balance must be paid back in full in five years. Loans secured before June 5, 2020, have a two-year term because they were disbursed before the PPP change.

What are the tax implications for PP loans? They are tax-deductible if you paid your business expenses with forgiven PPP loans.4,5

How do states tax PPP loans?

Congress allowed businesses that took out PPP loans to claim tax deductions for the expenses they paid with funds from a forgiven loan.

However, states including California and North Carolina treat tax rules for PPP loans differently than the federal government:

  • Under California state law, PPP borrowers cannot deduct expenses paid with forgiven loans when paying state taxes.
  • North Carolina does not consider forgiven PPP loans as taxable income, but companies cannot deduct covered expenses paid with forgiven PPP loans.

The legislatures in many states that tax forgiven PPP loans—Arizona, Arkansas, Hawaii, Maine, Minnesota, New Hampshire, Virginia and Wisconsin—have introduced bills to end this taxation. For the most current laws, see the Tax Foundation’s list of states that either tax forgiven PPP loans or do not deduct covered expenses.6

Will the Employee Retention Credit affect your taxes?

The CARES Act also introduced another reason businesses should retain workers: the Employee Retention Credit (ERC). This tax credit pertains to companies that have been harmed by government executive orders or are experiencing a sharp drop in sales.

For 2020, the ERC is equal to half of all qualified wages and salaries a company paid to employees between March 12, 2020, and December 31, 2020. The limit is $10,000 in wages per employee for all quarters.

For 2021, the government raised the credit to 70% of all qualified wages paid to workers from Jan. 1, 2021, through June 30, 2021. It’s limited to $10,000 in wages per employee for any quarter. Therefore, you are allowed to claim a maximum credit of $7,000 for each employee per quarter. Because the credit is only available for wages disbursed in the first two quarters of 2021, the maximum credit is $14,000 per employee.

Are Pandemic Unemployment Assistance benefits taxable?

For millions of Americans who lost their jobs in 2020 and had to deal with the dire financial consequences of COVID-19, their only financial lifeline was the pandemic unemployment benefits they received from the federal government.

Unfortunately, these unemployed workers will have to pay taxes on those unemployment benefits. According to the IRS, “unemployment compensation is taxable and must be reported on a 2020 federal income tax return.” 7

Also, taxable benefits include all state unemployment benefits and emergency federal benefits awarded under the CARES Act. These include an extra $600 as part of the Pandemic Unemployment Compensation (PUC) program and the two programs for self-employed and gig workers:

  • Pandemic Unemployment Assistance (PUA)
  • Pandemic Emergency Unemployment Compensation (PEUC).

Be your own tax pro

The PPP provided billions in aid to small businesses and independent contractors who kept workers employed during the COVID-19 pandemic and subsequent financial crisis.

If qualifying companies did not let employees go or cut wages, the loans could be forgiven, effectively turning them into full or partial grants. However, this depends on how borrowers used the funds.

Business owners are often responsible for filing their taxes. The good news is that if you paid your business expenses with forgiven PPP loans, you would receive a tax deduction for 2020.8,9 With this knowledge, you can maximize your government loan.

Sources:

  1. US Chamber. Will You Owe Taxes on Your Paycheck Protection Loan?
  2. American Action Forum. Tracker: Paycheck Protection Program Loans.  
  3. U.S. Small Business Administration. Paycheck Protection Plan.
  4. U.S. Small Business Administration Office of Advocacy. Yes, Small Businesses, Expenses Paid With Forgiven PPP Loans Are Deductible
  5. Journal of Accountancy. Expenses used for PPP loan forgiveness: Deductible or not? 
  6. Tax Foundation. “Which States are Taxing Forgiven PPP Loans?
  7. IRS.Gov. IRS: Unemployment compensation is taxable; have tax withheld now and avoid a tax-time surprise.
  8. U.S. Small Business Administration Office of Advocacy. Yes, Small Businesses, Expenses Paid With Forgiven PPP Loans Are Deductible.
  9. Journal of Accountancy. Expenses used for PPP loan forgiveness: Deductible or not? 

Our editorial content is intended for informational purposes only and is not written by a licensed insurance agent. Terms and conditions for rate and coverage may vary by class of business and state.

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