How Will PPP Loans & EIDL Advances Affect My State & Federal Taxes?
Trying to decipher IRS instructions regarding PPP loans and EIDL Advances can be confusing. We break the tax implications down for you so that it's easily digestible.
If you were like millions of other small business owners, you might have gotten a little bit of financial relief from the COVID-19 pandemic through the US government’s Paycheck Protection Program (PPP) or the Economic Injury Disaster Loan (EIDL) advance. Now, with tax time around the corner, you might have questions about how your income tax return will be affected. Are EIDL grants taxable? Is PPP loan forgiveness taxable income? Is a PPP loan considered taxable income for the self-employed? In this post, we’ll answer those questions and more.
Digging through IRS publications or trying to decipher information released by the SBA can leave you scratching your head. In this post, we will break the tax implications down for you so that it’s easily digestible. We’ll cover how PPP loans and EIDL advances affect your state and federal taxes, so you can be fully prepared when it’s time to file.
One thing to note is that laws surrounding these government loans have changed over the last few months. We will continue to monitor these changes and update this post accordingly.
Are PPP Loans Taxable?
PPP loans are not taxable on the federal level. PPP funds do not have to be included in your business’s gross income on your federal tax return. However, PPP funds may be taxable at the state level, depending on the local laws in your area.
Are PPP Loans Taxable At The Federal Level?
The Small Business Administration’s PPP loans gave billions of dollars to encourage small business owners to maintain their payroll and keep their workers employed. According to the SBA, over 5 million businesses received loans through this funding program.
Under this program, small business owners could receive up to two-and-a-half times their average monthly payroll (with a maximum cap of $10 million) to cover payroll and other critical business expenses, such as utilities, mortgage interest, and rent paid under a lease.
When spent on approved expenses, these loans are 100% forgivable, meaning that the funds are not required to be repaid. For expenses that weren’t on the SBA’s list, funds would be repaid with a low-interest rate and long repayment terms.
This program helped millions of businesses by providing over $5 billion to eligible applicants. For many, this funding came at the right time, allowing small businesses to keep their doors open and employees on staff. However, the program is over, and businesses are now applying for loan forgiveness or calculating how much money they owe. With tax season on the horizon, there’s the looming question: How will PPP loans affect federal income tax returns?
PPP loan funds that were not forgiven are similar to other loans in that they are not taxable. Unforgiven PPP loan funds are not included as part of taxable gross income for businesses and the self-employed.
Is PPP Loan Forgiveness Taxable?
For federal tax purposes, PPP loan funds that have been forgiven are excluded from your business’s gross income. That also includes anyone self-employed that received a PPP loan. In other words, any portion of your PPP loan that has been forgiven will not be included as part of your company’s taxable income.
Is There A PPP Loan Tax Deduction?
The IRS issued a notice that further clarifies how PPP loan funds should be handled for federal income tax returns, initially making it so that expenses paid with PPP funds could not be claimed as deductions.
Fortunately, in December 2020, Congress made a change that superseded this notice, stating, “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.
In layman’s terms, this means that expenses paid with PPP loan proceeds can be claimed as deductions.
In summary, this is what you should expect from your PPP loan come tax time:
- Forgiven loan funds are not counted as taxable income and may be deducted from your business expenses
- Loan funds that are not forgiven are not counted as taxable income and may be deducted from your expenses
Are PPP Loans Taxable At The State & Local Level?
While it’s clear that forgiven loan funds are not to be included in taxable income for federal tax purposes, things become a little more complicated when it comes to state and local taxes.
While your forgiven PPP loan funds may be exempt from federal taxation, you may still be required to claim these funds as taxable income when filing your state tax return. How your forgiven loan is taxed at the state level depends on your state’s compliance with the Internal Revenue Code (IRC). Over 20 states have rolling conformity, meaning that they conform to the IRC as changes and amendments occur.
Other states, however, have different rules when it comes to IRC conformity. These include:
- Static Conformity: Also known as fixed-date conformity; conforming with the IRC occurs on a specific date
- Annual Conformity: Conforms with the IRC on an annual basis
- Selective Conformity: Conforms with specific provisions of the IRC
Still confused? Don’t worry — you don’t have to become a tax professional to understand what this means for your business. What it boils down to is that different states have different conformity rules. In other words, while there are no federal tax implications for your forgiven PPP loan, there may be state implications based on where you live.
How does this affect you and your business tax return? In some states, you may be required to include PPP funds as part of your taxable income. To further complicate matters, some states also have restrictions on deducting business expenses paid for using PPP loan funds.
As with the other information contained within this article, rules may be subject to change. We here at Merchant Maverick will continue to update this article as changes occur.
Which States Are Taxing PPP Loans?
Understanding why some states are taxing PPP loans is confusing for anyone without tax experience. Instead of wading blindly through tax laws, use this chart to determine how taxation of PPP funds is handled in your state. This handy resource shows which states allow you to exclude PPP loans as taxable income. It also shows which states allow you to lower your tax liability by deducting expenses paid for using PPP loan funds.
|State||Excluded From Taxable Income||Expense Deductions Allowed|
|Rhode Island||Special Circumstances||✔|
|South Dakota||No State Income Tax||No State Income Tax|
|Wyoming||No State Income Tax||No State Income Tax|
While most states make it clear whether PPP funds are taxable and/or deductible, there are a few things to note if your business is located in one of the following states:
- California: An expense deduction is not allowed for publicly traded companies in California. Additionally, businesses that did not have a decline of at least 25% in gross receipts between 2019 and 2020 can not deduct expenses paid for using forgiven PPP loan funds.
- Nevada: While Nevada does not have a state income tax, it does have a Gross Receipts Tax (GRT) applied to a business’s gross sales. In Nevada, forgiven PPP funds are to be included in taxable gross revenue. Additionally, no deduction for business expenses paid for using PPP funds is allowed.
- Ohio: Ohio has both a GRT and individual income tax. For individual income tax purposes, forgiven PPP loans are excluded from taxable income, and business deductions are allowed. However, under the GRT, deductions for business expenses paid for using PPP funds are disallowed.
- Rhode Island: In Rhode Island, only forgiven PPP loans of $250,000 or less can be excluded from taxable income.
- South Dakota: South Dakota has no state income tax.
- Virginia: In Virginia, only the first $100,000 of PPP funds spent on business expenses can be deducted.
- Washington: Washington levies a GRT. Under the GRT, deductions for business expenses paid for using PPP funds are disallowed.
- Wyoming: Wyoming has no state income tax.
How The EIDL Loan Affects Taxes
Another loan you may have taken advantage of during the COVID-19 pandemic is the Economic Injury Disaster Loan, or EIDL. One notable difference between the EIDL for those affected by the coronavirus and past EIDLs is that the Small Business Administration offered an advance of up to $10,000 for qualifying small businesses. This advance allowed businesses to receive funds quickly. While EIDL funds must be repaid, the EIDL Advance was a grant that does not have to be repaid.
Funds obtained through the EIDL and EIDL Advance could be used as working capital or to cover any other operating expenses for businesses impacted by COVID-19.
Is The EIDL Grant Taxable?
If you received the EIDL loan, taxes on these funds work like any other business loan taxation. In other words, funds from the EIDL are not reported as taxable business income on your tax return. You can also lower your tax liability by deducting any expenses covered by the use of these funds.
But what about EIDL Advances? Is an EIDL grant taxable? Initially, funds from EIDL Advances were to be reported as taxable income. However, this decision was reversed under the Consolidated Appropriations Act. Now, funds from an EIDL Advance are not reported as taxable business income. Additionally, qualifying expenses can be written off to lower your tax liability.
Keeping receipts, bank statements, and other records can make it easy to claim your deductions come tax time. If you have any questions about your deductible expenses, consult with an accountant or tax professional.
Other COVID Tax Relief Options For Small Business Owners
Receiving PPP and/or EIDL funds isn’t the only way small business owners have been able to weather the COVID-19 storm. There are additional relief options out there in the form of small business deductions and tax credits that can help lower your tax liability and ease some of the financial burdens of the pandemic. COVID tax relief options for small business owners include:
- Writing off expenses paid for with PPP loan funds
- Writing off expenses paid for with EIDL loan and/or grant funds
- Claiming the Employee Retention Tax Credit
- Claiming tax credits for required paid leave provided by small and midsize businesses
If You Received A PPP Loan, Expect A Tax Audit
The SBA and the US Treasury have announced that all PPP loans in excess of $2 million will be audited. Loans that are less than $2 million are subject to an audit, and it has been reported that much lower loans have been scrutinized. What does this mean for you? In short, all recipients of the PPP loan should expect to be audited, as there is a higher probability that the IRS will audit you.
“Audit” is a pretty scary word, especially if you’ve never faced one before. However, the audit process should be pretty painless as long as you have your records in order and you used funds appropriately. Here’s how to make the process go as smoothly as possible:
- Don’t Procrastinate: Sure, an audit can be scary but ignoring it won’t make it go away. Read over your notice carefully and begin compiling your documentation as soon as possible.
- Keep All Records: Receipts, statements, payroll records, and PPP documentation should be kept on file for at least six years after your PPP loan is fully repaid or forgiven.
- Make Copies: If you’re sending off documentation, make sure to send copies. Always retain your original documentation in case you need it at a later time.
- Hire A CPA: A CPA, unlike a regular accountant, will be able to represent and defend your business against the IRS, if necessary. A CPA can also offer important advice for tax preparation and future audits.
Did you receive a PPP loan, and you’re being audited? Check out our post, PPP Loans & Tax Audits: What Your Business Needs To Know, so you’ll know what to expect.
Other PPP Tax & EIDL Tax FAQs
Didn’t find the answers you were looking for? Take a look at some of the most-asked questions about how PPP and EIDL loans may affect your taxes.