How Will PPP Loans & EIDL Advances Affect My State & Federal Taxes?

As a small business owner, odds are you were affected by the COVID-19 pandemic. Whether this meant shutting your doors temporarily, reducing your number of customers, or shifting to remote work, the pandemic has undoubtedly caused some challenges for your business. If you were like millions of other small business owners, you got at least a little bit of financial relief through the US government’s Paycheck Protection Program (PPP) or the Economic Injury Disaster Loan (EIDL) advance.

So, now, here we are. You’ve received your funding, you’ve spent it, and perhaps you’ve even applied for loan forgiveness. But there’s still a nagging thought in the back of your mind: How does this affect your taxes? Do you have to pay taxes on your PPP loan? Will you be on the hook with the IRS for the funding you received with the EIDL advance?

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.

New Information: How The PPP Loan Affects State & Local Taxes

Under the Coronavirus Aid, Relief, and Economic Security Act, the way that forgiven loan funds are taxed at the federal level is different than usual (more on that later). 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 is dependent upon 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. This includes:

• Static Conformity: Also known as fixed-date conformity; conforms 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.

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), tax that is applied to the gross sales of a business. 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 that were 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 PPP Loan Affects Federal Taxes

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, as we approach the end of the year, the program is over, and businesses are now applying for loan forgiveness or calculating how much money they owe. For many business owners, though, the end of the year also signals tax season on the horizon and the looming question: How will PPP loans affect federal income tax returns?

Are PPP Loans Taxable?

For federal tax purposes, PPP loan funds that have been forgiven are excluded from your business’s gross income. 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.

PPP loan funds that were not forgiven are similar to other loans. Unforgiven PPP loan funds are not included as part of your taxable gross income.

PPP Loans & Tax Deductions

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

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 are required to 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.

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.

How The Employee Retention Credit Affects Taxes

Small business owners may be eligible to claim the Employee Retention Credit. This credit is available to businesses with 500 or fewer employees that also meet the following criteria:

• Required by a governmental authority to fully or partially suspend operations as a result of COVID-19, or
• Experienced a gross decline in receipts of at least 50% in a calendar quarter in 2020 when compared to the same quarter in 2019

If you are eligible, you can receive a credit of up to 50% of eligible wages paid per quarter to each employee. Maximum wages per quarter per employee are capped at $10,000. That means you can claim a maximum of $5,000 per quarter per employee. You do not need to wait to claim this credit when you file your annual income taxes. Instead, credits can be claimed on your quarterly tax return.

Additional legislation was enacted that extended the Employee Retention Credit through 2021.

Under the Taxpayer Certainty and Disaster Tax Relief Act of 2020 and the American Rescue Plan of 2021, employers can claim a tax credit against their share of Social Security taxes equal to 70% of eligible wages paid to employees from January 1, 2021, through December 21, 2021. The maximum credit per quarter under these laws is $7,000 per quarter per employee. For 2021, a maximum of $28,000 per employee can be claimed as a credit.

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, as long as you have your records in order and used funds appropriately, the audit process should be pretty painless. 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 & 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.