You don’t have to report a Paycheck Protection Program (PPP) loan on your taxes unless your business is based in Florida, Nevada, or Utah. This is because the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) expressly excludes PPP loans from federal gross income, which also means that it is excluded from federal income tax.
However, Florida, Nevada, and Utah do have state laws that impose taxes on PPP loans. Therefore, if your business is based in any of these three states, you have to report PPP loan as taxable income. Most states also allow you to deduct expenses paid for using PPP loans, thus lowering your tax liability further.
PPP loan tax implications: what you need to know
There’s no doubt that the PPP has provided small businesses with a lifeline to meet their expenses and keep workers employed during the coronavirus pandemic. However, the tax implications that come with these loans can still be confusing. And with tax time quickly approaching, many business owners are wondering: do you have to report PPP loans on your taxes?
Usually, forgiven loans are taxable by the IRS for federal income tax purposes. However, section 1106 (i) of the CARES Act excludes forgiven PPP loans from taxable income. This makes it unnecessary to report a PPP loan on taxes. In fact, you don’t have to report a PPP loan on your tax return whether it was forgiven or not. The only difference is that if your loan is forgiven, you won’t be required to make principal or interest payments on it.
How can you get your PPP loan forgiven?
If you got a PPP loan, then it can be forgiven if you used at least 60% of the proceeds on employee payroll. You are allowed to use the remaining 40% on business expenses, including operation costs, utility costs, mortgage interest, rent expenses, repair of property damage from civil unrest, and expenditure on worker protection.
In case you’re looking to have your PPP loan forgiven, you can download forgiveness forms from the Treasury Department’s website. Once filled, submit the forms to the private lender from where you obtained the PPP loan. Keep in mind that forgiveness is based on you continuing to pay your employees normal rates for a period between 8 and 24 weeks after receiving the loan.
If your business is eligible, your PPP loan may be forgiven on a federal level and you won’t need to pay taxes on those amounts. You won’t have to report the loan on your taxes either.
Which states are taxing forgiven PPP loans?
Florida, Nevada, and Utah are taxing forgiven PPP loans while Rhode Island has a tax on PPP loans that exceed $250,000. All the other states do not have a tax on Paycheck Protection Program loans.
So, why the discrepancy? When Congress enacted the CARES Act on March 27, 2020, the intention was to exclude forgiven PPP loans from taxable income at the federal level. However, the Act did not directly amend the Internal Revenue Code, which considers forgiven debt as taxable income. Thus, under normal circumstances, a forgiven PPP loan would still be taxable, which would contravene Congress’ intentions.
To avoid confusion, lawmakers passed the Consolidated Appropriations Act (2021) on December 21, 2020. Among other things, the Act specified that any forgiven PPP loan is exempt from tax at the federal level and that small business expenses paid for using PPP loans are deductible as well.
Both the CARES Act and the Consolidated Appropriations Act passed legislation at the federal level. However, states usually use the IRC as their starting point for state tax codes. Since the IRC does not exempt a forgiven PPP loan from taxable income, states had two options:
Adopt a rolling conformity and use federal tax changes that exempt PPP loans from taxable income, or
Enact individual laws based on the IRC, which includes forgiven loans (including forgiven PPP loans) in taxable income.
While a majority of states went with the first option, Florida, Nevada, and Utah chose the latter. Rhode Island, for its part, levied a tax on PPP loans that exceed $250,000. Along the same lines, some states adopted federal provisions for PPP loan deductibles while others like California, Hawaii, Nevada, Ohio, Virginia and Washington imposed their own.
Below is a state-by-state table with PPP loan tax implications as well as tax deductions on PPP loan expenses.
A majority of states make it clear that PPP loans are excluded from taxable income. However, here are the points to keep in mind if your business is located in Florida, Nevada, Rhode Island, Utah, California, Ohio, South Dakota, Virginia, Washington or Wyoming:
Florida, Nevada and Utah tax PPP loans, which means that if your business is located in any of those states, you have to report the loan on taxes. Rhode Island taxes PPP loans that exceed $250,000. If your Rhode Island-based business qualified for an amount higher than that, you also have to report the PPP loan on taxes.
Nevada doesn’t have state income tax. However, the state imposes a Gross Receipts Tax (GRT) on the gross sales of a company. if your business got a PPP loan, then it should be included in taxable gross revenue. Additionally, expenses paid for using PPP loan funds are not deductible in Nevada.
Washington also has a GRT and doesn’t allow deductions on funds used for business expenses.
In California, any business whose gross receipts didn’t decline by at least 25% between 2019 and 2020 can’t deduct expenses paid for using PPP loan proceeds. However, the loan is not part of taxable income, thus you don’t have to report it on taxes.
Ohio has both income tax and GRT. While forgiven PPP loans are excluded from taxable income, you can’t deduct business expenses funded using PPP loan proceeds because of GRT.
Both South Dakota and Wyoming have no state income tax, which means that you don’t have to report PPP loans on taxes if your business is in either of these two states.
While Virginia allows you to leave out forgiven PPP loans on taxes, only the first $100,000 of the funds used on business expenses are tax deductible.
Commonly asked questions about PPP tax implications
If you still have questions about the implications of a forgiven PPP loan, here are some answers that offer more clarity:
Do you need to report PPP as income?
No. The Paycheck Protection Program is excluded from income. It’s simply an emergency benefit that the federal government introduced to shield small business owners and their employees from the effects of the coronavirus pandemic. As such, it’s not business income.
Can you get a PPP loan if you owe back taxes?
Yes. Tax debt doesn’t disqualify you from PPP loan eligibility. Eligibility rules set by the CARES Act do not exclude businesses with back taxes. Similarly, ineligibility rules set by the same Act do not include businesses with back taxes.
Your business meets the qualification requirements if:
It has 500 or fewer employees
It’s a small business or a non-profit organization
It was in operation as of February 15, 2020
On the flipside, a person is ineligible if:
They are involved in illegal activity
They are a household employer
They or their business partner is on probation, parole, incarcerated or facing criminal charges in any jurisdiction
They have ever defaulted on any SBA-guaranteed loan within the last 7 years.
As you may have noticed, eligibility and ineligibility requirements do not consider back taxes. That said, a lender is more likely than not to deny your business a PPP loan if you have unpaid or delinquent state or federal taxes and if you’re a subject to a tax lien. This is down to creditworthiness more than eligibility requirements set forth by the CARES Act.
Is PPP taxable income for the self-employed?
No, if you are self-employed and normally taxed on business profit, then the forgiven portion of your PPP loan is not subject to income tax. This is because you’re not required to report the loan as a business expense or taxable income.
Furthermore, the Owner Compensation Replacement rule allows you to pay yourself – tax free – using proceeds of a forgiven PPP loan. However, you can only take the full amount of owner compensation share if you have used the PPP loan to cover expenses for at least 11 weeks.
What if your business doesn’t use payroll?
If you’re a business owner who doesn’t take a salary through a payroll service, you may still pay yourself using the Owner Compensation rule and the salary will be deductible. There’s a catch, though. Your business must not be a C-corporation or S-corporation. These two company structures are taxed separately from their owners. Their dividends or distributions are not considered to be self-employment income or salaries. Therefore, you can’t have your own payment covered through the PPP loan.
Can you deduct expenses paid for with a PPP loan?
Yes, expenses paid for using PPP loans are deductible in all states except California, Hawaii, Nevada, North Carolina, Ohio, Virginia and Washington. More specifically, if your business is based in Hawaii, Nevada, North Carolina, or Washington, you simply can’t deduct expenses paid for using a PPP loan.
In California, you can’t deduct expenses paid for using a PPP loan if your business’s gross receipts didn’t decline by at least 25% between 2019 and 2020. Thus, if your gross receipts declined by over 25% within that period, you’re entitled to deductibles.
Prior to the passing of the S.B. 18 law on March 31, 2021, Ohio didn’t allow business owners to deduct expenses paid for using PPP loans. Therefore, any expenses preceding this law are not deductible. However, you can fully deduct eligible business expenses that you incurred after the law came into effect on March 31, 2021.
In Virginia, only the first $100,000 of PPP funds used on business expenses are tax deductible.
How to report PPP loan on tax return
Filing small business taxes is pretty straightforward. The good news is that a forgiven PPP loan doesn’t make the process any harder than it was in previous years. There are, however, a few things to keep in mind as you prepare to report and file tax returns:
You can’t use proceeds of a PPP loan to pay business taxes. They are specifically meant for non-tax expenses like payroll, utilities and interest.
You’re still allowed to claim employee retention tax credit provided your business meets the requirements. However, you cannot claim wages paid using a forgiven PPP loan. Your business is eligible for employee retention credit if i) it reported a 20% reduction in gross receipts compared to the previous year, and ii) you continued to pay employees despite having to temporarily shut down due to coronavirus restrictions. While these provisions became law on December 27, 2020, they are retroactive to March 12, 2020. You can use the credit for all wages paid until July 1, 2021.
Taking out a PPP loan doesn’t affect your family and sick leave tax credits as outlined by the Families First Coronavirus Response Act (FFCRA). However, you’re not permitted to pay for sick and family leave wages using the proceeds of your PPP loan.
The CARES Act allows you to defer payroll taxes even if you got a forgiven PPP loan. However, 50% of accumulated taxes from 2020 must be paid by December 31, 2021 and the remaining 50% must be paid by December 31, 2022.
With those points in mind, here’s a step-by-step guide for reporting PPP loan on your tax return:
Step 1: Gather your records
Make sure that you have all the records that you need to report your business income. These include bank deposit slips, invoices, receipts, cash register tapes and business credit card charge slips. Essentially, you want to have all the records that accurately capture your business revenues and expenses. If you use an accounting software like QuickBooks or Xero, it will track all these things for you, making your work much easier.
Step 2: Get the right form
There are various IRS tax forms based on types of business. If you are a sole proprietor or contractor, you’ll need to fill in Schedule C on the IRS Form 1040. In case the business is a partnership, then you’ll need to use Form 1065. Single-member LLCs use Schedule C, E or F of Form 1040 while C-corp and S-corp taxes are reported on IRS Form 1120 and IRS Form 1120S respectively.
All these forms are available for download on the IRS’ website.
Step 3: Fill out the form
Schedule C is the easiest form to fill since it’s only two pages long. It provides you with a list where you enter your business income, expenses and deductibles.
Subtract deductibles from expenses, then subtract net expenses from business earnings and you’ll have your net profit or loss. Keep in mind that you don’t have to report PPP loan on taxes, so you don’t need an entry for it. But you can deduct expenses paid for using the loan.
When a loan is forgiven, the lender typically issues a Form 1099-C to indicate the cancellation of debt. However, with the PPP loan forgiveness, you don’t need this form. You only need to submit your Schedule C.
Forms 1120 and 1120S capture the same information as Schedule C, albeit with more details. Again, you don’t need to report PPP loans on these tax forms, but you can deduct expenses.
Step 4: Beat the deadline
If you use Schedule C to file tax returns, then you must attach it to your Form 1040 for personal income returns. This has a deadline of April 15.
If you’re filing quarterly estimated income tax return for a corporation, then the deadlines to keep in mind are:
First quarter: due April 15.
Second quarter: due June 15.
Third quarter: due September 15.
Fourth quarter: due December 15.
Want to learn more about small business management and finances? Check out the Nearside blog.