When COVID-19 hit and stay-at-home orders went into effect across the United States, the economy entered an unprecedented slow down—and small businesses were hit especially hard.
With significantly decreased revenue, many small businesses had no way to cover their costs. But when the Coronavirus Aid, Relief, and Economic Security Act (more commonly known as the CARES Act), it provided a variety of relief options for small businesses—including the Paycheck Protection Program.
The Paycheck Protection Program is a loan program administered by the U.S. Small Business Association (SBA). The program initially oversaw nearly $350 billion in loans for small businesses impacted by the coronavirus—but after depleting those funds in less than two weeks, in late April, Congress passed new legislation that replenished the Paycheck Protection Program with an additional $310 billion in funding for small businesses.
The biggest draw of PPP loans has been that, unlike other types of emergency funding (like Economic Injury Disaster Loans, or EIDL, or loans through the Main Street Lending Program), up to 100 percent of these loan amounts are eligible for loan forgiveness if the loan proceeds are used on approved business expenses (including payroll costs, mortgage interest, rent, and utility payments) during the covered period. The Paycheck Protection Program also allows business owners to defer 50% of their annual payroll taxes to December 2021 for an added tax benefit.
There’s no denying that Paycheck Protection Loans were an integral part in keeping businesses afloat during the pandemic. But now that so many small businesses have accepted these loans, the big question on everyone’s mind is how will PPP loans impact 2020 business taxes?
Let’s take a look at some of the biggest tax questions small businesses have about PPP loans:
Will you be taxed on your Paycheck Protection Program loan?
So, the first questions—will you be taxed on your PPP loan?
The entire purpose of the Paycheck Protection Program was to get businesses the money they needed to keep their operations moving forward. But that purpose wouldn’t have been very effective if accepting Paycheck Protection Loans would leave you with a huge bill for the 2020 tax year.
Which is why, under the CARES Act, your forgiven loan amount won’t be considered taxable income. So, for tax purposes, the funds you receive from your Paycheck Protection Program loan aren’t taxable.
So, for tax purposes, you won’t have to worry about paying tax on any PPP funds that you’ve used for payroll costs, rent, mortgage interest, or other approved expenses.
Will PPP loan forgiveness impact your ability to claim tax deductions?
There is, however, a caveat.
The IRS recently released a notice that explained the relationship between PPP loans and tax deductions, which reads as follows:
“This notice provides guidance regarding the deductibility for Federal income tax purposes of certain otherwise deductible expenses incurred in a taxpayer’s trade or business when the taxpayer receives a loan (covered loan) pursuant to the Paycheck Protection Program under section 7(a)(36) of the Small Business Act (15 U.S.C. 636(a)(36)). Specifically, this notice clarifies that no deduction is allowed under the Internal Revenue Code (Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136, 134 Stat. 281, 286-93 (March 27, 2020) and the income associated with the forgiveness is excluded from gross income for purposes of the Code pursuant to section 1106(i) of the CARES Act.”
Essentially, this prevents businesses from receiving a double tax credit by excluding a forgiven PPP loan from their taxable income and claiming the expenses they used the PPP funds for as tax deductions. Essentially, any expenses that you paid for with PPP funds are ineligible to be claimed as a tax deduction.
So, let’s say you received a $250,000 Paycheck Protection Loan—and you spent 100% of the loan proceeds on approved expenses, which qualified you for loan forgiveness.
When it’s time to file your taxes, you won’t include that $250,000 in your taxable income. But you also can’t claim any of the tax deductions that would typically apply to the expenses you used PPP funds more—which means that, while you don’t have to claim the $250,000 loan amount as taxable income, you also don’t get to claim any related tax deductions you might have otherwise benefitted from had you used your own funds to cover those expenses.
Which tax deductions are related to the Paycheck Protection Program?
There are a number of tax deductions that could be impacted by the Paycheck Protection Program, including:
- Interest tax deductions. If you have a mortgage tied to your business, you can deduct the mortgage interest on your taxes—but that doesn’t apply if you used PPP funds to cover your interest payments during the covered period.
- Rent. If you rent an office space, you can typically deduct that cost from your taxable income. But if you used your Paycheck Protection Program loan to cover rent, you won’t be able to take a rent tax deduction for that time period in 2020.
- Utility payments. Internet, electricity, water, and any other utilities necessary to run your business are considered deductible business expenses—but if you used PPP loans to cover those utility bills, you won’t be able to claim that deduction on your taxes.
- Payroll taxes. As mentioned, the Paycheck Protection Program allows recipients to defer a portion of their payroll taxes through the end of 2021—but if you defer, that’s also not a deduction you’ll be able to take.
Keep an eye out for updates on the policies surrounding PPP loans and tax deductions
While the Paycheck Protection Program has undoubtedly brought a huge benefit to small businesses, the fact that you can’t deduct expenses paid for by PPP loans isn’t the news many small business owners were hoping for. But there is always the chance that new legislation could pass reversing the decision and awarding small businesses the right to claim deductions for covered expenses—so, as a business owner, the best thing you can do is keep yourself informed and aware of any potential policy changes to the Paycheck Protection Program, loan forgiveness, and related tax deductions