PPP Loan Forgiveness and Taxability (Paycheck Protection Program)
While the Paycheck Protection Program (PPP) that was part of the Cares Act that was passed by Congress back in March 2020 is deemed forgivable by the federal government as long as the loan proceeds are used for qualifying costs – payroll; health insurance for paid sick, medical, or family leave; mortgage interest payments; rent; and utility payments – and 60% of the loan proceeds are used for payroll costs, then the federal government will forgive the loan. While a loan does not generate taxable income, a forgiven loan generally does. Congress addressed, to a degree, that issue by specifically stating in the CARES Act that forgiven PPP loans are not includable in taxable income.
Then Come The States
Each state that implements an income tax has its own revenue code that conforms in some degree to the Internal Revenue Code (IRC). Twenty-one states and the District of Columbia are rolling conformity states so they automatically conform to the most current IRC for both individual and corporate income taxes. Taxpayers with forgiven PPP loans in those jurisdictions will most likely exclude the forgiven loan proceeds from taxable income at the federal and state level, but it is not a guarantee.
IRS Treatment of PPP Loan Proceeds Can Impose Unexpected Costs
On April 30, 2020 the IRS released Notice 2020-32 to provide some guidance on the deductibility of otherwise deductible expenses incurred in a trade or business if a taxpayer received a loan through the Paycheck Protection Program (PPP) that is eventually forgiven. The notice states:
“Specifically, this notice clarifies that no deduction is allowed… for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan … and the income associated with the forgiveness is excluded from gross income….”
The IRS has taken the position that small businesses that have used a PPP loan to keep paying their employees during the pandemic will NOT be allowed to deduct the normally deductible ordinary and necessary business expenses of payroll, mortgage or rent payments, and utilities paid with the PPP loan proceeds. The agency’s position is based on the concept of a “double tax benefit” (also called double dipping) because the loan proceeds, if forgiven, would not be included in gross income and the business would claim a deduction for the expenses allocated to the forgiven loan proceeds.
The IRS’s interpretation of the deductibility of these expenses could lead to increased tax liabilities for businesses that have income for the tax year but cannot deduct all ordinary and necessary business expenses, such as payroll, imposing an unexpected hardship.
Check With Your Tax Preparer And Keep Detailed Records and Receipts
As always, IRS and State rules can change, and the rules on the PPP forgivable loans are no exception.
Here are some things you need to do before the end of the year:
Check with your tax preparer and ask what the rules are for your state, and how you should treat the PPP loan deposit and the expenses paid from that loan in your accounting records. Double check again before mid-December just in case the rules have changed.
If Your State Will Tax You On The PPP Loan As Income
If the forgivable loan is going to be taxable in your state, your accountant may recommend that when you record the loan deposit you should put it in a separate INCOME account in your chart of accounts and name it something like “PPP Loan Income”.
Then you should record the expenses you paid from that income in new chart of accounts parent entry named “PPP Expenses” and record the payments you made from the loan proceeds as sub accounts under this parent account so they are easily identifiable. For example, you would have 2 accounts for Payroll Expenses, 2 accounts for utility expenses, and 2 accounts for Rent/Mortgage expenses, so you can easily identify what the PPP Loan proceeds were used for. Your accountant and tax preparer can help with this.
If Your State Will NOT Tax You On The PPP Loan As Income
If the forgivable loan is NOT going to be taxable in your state, your accountant may recommend that when you record the loan deposit you should put it in a separate OTHER LIABILITY account in your chart of accounts and name it something like “PPP Loan”.
Then you would book the payments you made for payroll, utilities and rent/mortgage as payments toward reducing the principal balance of the “PPP Loan” to show the reduction of the loan balance.
Keep A Separate File Of PPP Related Records And Receipts
Make copies of everything that pertains to your PPP loan and expenses paid from it. This would include the deposit slip showing when and what bank account received the loan deposit, Copies of all checks and reports used to pay for payroll, utilities and rent/mortgage, and copies of any correspondence from the SBA (lender) and from your bank or other entity that assisted you in applying for the loan, and copies of all of the loan and loan forgiveness applications you filled out.
How to get PPP Loan Forgiveness
Loan Forgiveness depends on how you spend your PPP loan during the eight (if applicable) or 24 weeks after receiving it.
Here are some basic tips on how to get it fully forgiven – and keep in mind, any of the loan proceeds you didn’t use on qualified expenses can be paid back early to the lender to avoid having to claim it as income.
Use it for eligible expenses (60% minimum on payroll, 40% maximum on utilities or rent/mortgage)
Keep your employee headcount up
Don’t reduce an employee’s wages by more than 25%
Document everything meticulously
Talk with your lender for advice
Apply for loan forgiveness
In a nutshell, the PPP forgiveness calculation factors in these three things 1) what you spent your PPP loan on, 2) your employee headcount, and 3) whether you reduced an employee’s wages by more than 25%.
Here is some helpful information on how to apply for forgiveness from 1st Summit Bank:
As always, check with your accountant and tax preparer if you have specific questions. They should be able to answer them all.