If you received a PPP loan in 2020, are in the process of getting one now, or both, you should know how the loan will affect your taxes.
Understanding PPP tax implications can help you better manage your business finances and prepare for tax season.
Are PPP Loans Taxable?
Federally, PPP loans are not taxable. Your business does not have to include PPP funds in its gross income on its federal tax return. The state may tax PPP funds, depending on the local laws in your area.
PPP loan funds that have been forgiven are excluded from your business's gross income for federal tax purposes. That includes self-employed individuals who received a PPP loan. Your company won't have to include any forgiven portions of your PPP loan in its taxable income.
Forgiven PPP loans are not taxable
As a rule of thumb, any business loan forgiven with the intention of recouping the debt is taxable income.
This isn't the case with Paycheck Protection Programs. According to Congress and the IRS, forgiven PPP loans will not be considered income. It does not matter whether the entire loan is forgiven or only a portion.
Like other loans, PPP loan funds that were not forgiven are not taxable. For businesses and self-employed individuals, unforgiven PPP loan funds are not included in gross income.
How will PPP loans affect taxes?
In the wake of the Covid pandemic, businesses were economically disadvantaged during the various phases of lockdown. Halfway through 2020, the paycheck protection program (PPP) became functional. The aim of the $350 billion (initially) worth program is to help small businesses cope financially during the pandemic.
Later, in 2021, the exhausted allocated fund for the PPP loan was renewed to continue supporting small businesses; to reduce the number of laid-off staff, continued payment of employees, rent payment, and other utility costs.
Through any SBA lender or federal depository, any business; non-profit, contractors, self-employed persons, LLC, and a sole proprietorship can apply. Keep in mind that the number of employees must be no more than 500 people or fewer.
The PPP loan is open to American businesses, businesses contributing significantly to America's economy, and businesses with primary possessions in the US.
Is There A PPP Loan Tax Deduction?
A notice from the IRS clarified how PPP loan funds should be handled for federal income tax returns, initially barring deductions for expenses paid with PPP loan funds.
Fortunately, Congress made a change in December 2020 that overrode this notice, which states, "no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income provided," in Section 1106 of the CARES Act.
This means that expenses paid with PPP loan proceeds can be deducted.
Is PPP loan Forgivable?
The PPP loan is forgivable but with requirements attached. 75% of the loan must be spent on employees' payment within 8-24 weeks. To break it down further, employees' payment either paid or scheduled to be paid within 8 to 24 weeks must equal to about 75% of the total PPP loan. The 25% serves as the running cost of the business which incorporates the rent, utility costs, and other expenses to keep the business functional.
On meeting these requirements, the business must also apply for loan forgiveness on or before the loan matures. Based on these criteria, the loan can be partially or fully forgiven. When applying for forgiveness, it's paramount that documents show consistency in paying employees fully without firing any. The implication of this is that employees must be paid the same rate as before the pandemic and none of them must be fired.
Re-hiring of laid-off workers is instructed alongside restoring the earnings to the original. Under no circumstances should the earning get increased to meet up with the required payroll spending.
Is the PPP forgiveness loan Taxable?
According to (CARES) Coronavirus Aid, Relief, and Economic Security Act, there have been debates on if PPP is taxable or not. Despite arguments from IRS regarding taxable expenses, congress has shed light; stating that only income will be liable for tax charges. In view of this, small businesses do not pay tax on the money received.
The sole purpose of the money disbursed to businesses is to keep them up and running. To do that easily, taxes are removed to avoid putting extra burdens on such businesses.
Keep in mind that based on initial understanding, the expenses covered by the PPP loan are not tax-deductible. But with clarifications as of December 2020, the stimulus act changes occurred. Now, expenses carted to by PPP loan are eligible for tax deductions much to the relief of businesses.
Further, the clarification translates to relief for small businesses. The PPP loan would in no way affect the tax filling procedure of businesses.
Failure to comply with the PPP loan requirements disqualifies a business from enjoying the loan forgiveness option. Compliance with the spending percentage on the specified aspects guarantees loan forgiveness. For businesses unable to comply they miss out on loan forgiveness.
The IRS Stand and Implications
Over the months, the IRS has taken a firm stand against Congress' policy of PPP loan forgiveness and the later adjustment on the tax deductibles. Added to frowning at loan forgiveness, the adjusted understanding of tax deductions passed by Congress further raised eyebrows. Not only of the IRS but some scholars who also believe the idea of allowing expenses covered by forgiven PPP loan to be tax deductible is a double benefit.
To break it down, some expenses allows a business to benefit from the tax deduction. This seems valid because the tax benefits are an incentive(sort of) on the money earned by the business. Now, since the fund used to cater to expenses is free (forgiven loan), the question is why should businesses still enjoy tax benefits. This is where the IRS stands against the CARES policy of tax deduction benefits on forgiven loans claiming it's a "double-dip". Despite the double rounds and continuous rolling out of the PPP loans, the IRS still maintains its stand against the policy of " double gain" (loan forgiveness and tax deductions for expenses covered by it).
Loan Repayment Criteria
In reality, not every applicant who benefits from the loan provider will be eligible for forgiveness. Some must pay back due to several reasons.
The loan repayment starts after two years. Should a business decide to pay earlier than that, there are no charges or penalties. Early repayment is free of extra charges, so if possible, the loan can be paid before the due period. In terms of the interest, there's a fixed rate of 1% charged on the list to be paid alongside the principal amount.
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