The approaching tax season has been raising fresh questions for everyone. Business owners who received a loan through the PPP (Paycheck Protection Program) want to know if PPP loans are taxable.
The PPP originated from the CARES (Coronavirus Aid, Relief, and Economic Security) Act, which was signed into law in March 2020. It was intended to provide American small businesses with eight weeks of cash-flow assistance through 100 percent federally guaranteed loans. The loans are backed by the SBA (Small Business Administration). It was a form of financial aid provided to businesses that were forced to close their doors and furlough workers due to restrictions amid the COVID-19 pandemic.
Why did PPP close down early?
The original deadline to apply for a PPP loan was May 31, 2021, but it winded down on May 28 instead. There was a high volume of applications and there weren't enough remaining funds. The PPP quickly ran out of funds for both the First Draw and Second Draw.
PPP loans are low-interest, with a 1 percent interest rate, but many loan recipients are eligible for full PPP loan forgiveness. The PPP program provided almost $800 billion of forgivable loans to small businesses.
What's the tax treatment for PPP loans?
However, the tax treatment for loans hasn't been very simple. Until November 18, 2021, the question hadn't been answered about whether a loan can be considered to be forgiven for tax reporting purposes. The IRS released Revenue Procedure 2021-48, in which it issued more guidance on the tax treatment of PPP loan forgiveness.
Forgiven PPP loans don't constitute taxable income.
According to the Consolidated Appropriations Act of 2021, the forgiveness of the PPP loans didn't constitute taxable income. This applies whether your entire loan is forgiven or just a portion. Another point that needed clarification was the treatment of expenses incurred when using the funds from the PPP.
Originally, the IRS contended that taxpayers who receive forgiveness for a loan might not "double-dip" by also deducting the amount paid out to employees as expenses. However, this was later reversed, which resulted in expenses paid being treated as tax-deductible too.
PPP funds used for expenses can be claimed as deductions.
Essentially, there are double tax benefits for PPP loan recipients. Not only does it make the loan income-tax-free, but it also allows businesses to claim income deductions on expenses paid. However, business taxes still aren't an allowable use of PPP funds. If you use your PPP loan to pay your business taxes, that amount won’t be forgiven.
What about the employee retention tax credit?
These businesses can claim the employee retention tax credit. However, an important consideration to claim this tax credit is that you should have continued to pay employees despite being temporarily shut down due to COVID-19 restrictions or suffering a 20 percent drop in gross receipts compared to the same quarter in the prior year.
The IRS’s new guidance also says that a taxpayer might treat the tax-exempt income as a result of PPP loan forgiveness as “received or accrued” at the time that any of the following three options occurred:
- When eligible expenses are paid or incurred
- When the taxpayer files its PPP forgiveness application
- When the forgiveness is granted