Personal Finance

Surprise! PPP Loan Forgiveness May Not Be Tax-Free For Everyone

The Paycheck Protection Program (PPP) was designed to help small businesses keep their doors open and employees paid during the height of the pandemic, and it was likely a huge factor in helping our economy stay afloat throughout the second half of 2020 and the first half of 2021. As most people know, loans from the PPP program were also available in waves, first with the initial PPP offering and then with the Second Draw PPP loans. Ultimately, the program will end on May 31, 2021, which means businesses still have a few weeks to apply through a private lender. 

While easy loan approval is always a good thing, the Paycheck Protection Program (PPP) came with the added benefit of loan forgiveness for businesses who met eligibility requirements. To have a First Draw PPP loan amount forgiven, businesses had to show that employees and their pay were maintained, and that loan proceeds were used to fund payroll costs and other required expenses. Specifically, 60% of loan proceeds had to be used for payroll expenses. 

With the Second Draw PPP, loan proceeds were for the second 8 to 24-week period following loan disbursement. The same requirements apply for forgiveness, including maintaining employees and pay, using loan proceeds on payroll and other eligible expenses with 60% required to cover payroll specifically. 

Businesses who were able to meet all these requirements could wind up with their entire PPP loan amounts forgiven on a federal level, and with no income taxes due on these amounts. 

According to Phillip Kryder, CPA and Vice President, Special Projects at First Internet Bank, the original intent of Congress with the passing of the Consolidated Appropriations Act for 2021 was that forgiven PPP loans would be tax-free at the federal level, which is a departure from the way forgiven federal debt is normally treated. Not only that, but Congress also intended that expenses paid for using the PPP loans would also be deductible.

“So for federal purposes, the loan is both excluded from income, and the expenses paid for by the PPP proceeds are deductible,” said Kryder. “This is a significant positive emergency benefit Congress intended for businesses affected by the pandemic.”

Watch Out For State Taxes On PPP Loans

Unfortunately, your state may still force you to pay income taxes on forgiven PPP loan amounts, which could be substantial depending on how much you were awarded. Taylor English law partner Christina Moore also points out that some states are still making changes in terms of tax treatment for PPP loans.

For example, California changed course on April 28, 2021 when Governor Gavin Newsom signed legislation would allow most California businesses that received a forgiven PPP loan to avoid taxes on forgiven amounts if they can show at least a 25% reduction in profits for at least one quarter as a result of the pandemic. Moore also says that, on March 15th, 2021, Virginia signed into law a bill that excludes forgiven PPP loans from taxable income. This new legislation also “offers Virginia specific deductions up to $100,000 in expenses paid using forgiven PPP loans.” 

While plenty of changes are still in the works, here’s a rundown of some of the states who are currently planning to tax forgiven amounts on PPP loans:

  • California: PPP expenses may be deductible if certain income changes are met
  • Florida: Does not exclude forgiven loan amounts from taxable income
  • Hawaii: PPP expenses are not deductible
  • Minnesota: Does not exclude forgiven loan amounts from taxable income
  • Nevada: Treats PPP loan as taxable gross income
  • North Carolina: Taxpayers may not deduct expenses paid by PPP loan proceeds for NC income tax purposes
  • Texas: PPP loans are taxable for the state franchise tax
  • Utah: Does not exclude forgiven loan amounts from taxable income
  • Vermont: PPP loans forgiven in 2020 were not taxable, and business expenses paid in 2020 were deductible last year. Vermont is not excluding forgiven loan amounts for tax purposes in 2021. 

How To Plan For Taxes On Forgiven PPP Loans

While PPP loans were created to help businesses stay afloat during one of the worst economic times in our history, hardly anything in life is “free.” If your state requires it, you should absolutely begin planning to pay income taxes on forgiven loan amounts, whatever they wind up being.

Moore says she recommends business owners “familiarize themselves with the applicable state position on PPP loans and ensure they are tracking any active legislation or watching for any proposed legislation.” After all, several states have changed positions on this recently, and there may be more state-based changes to come.  

Hope for the best, but make a plan for the worst. After all, it seems inevitable that some states will stay the course and tax forgiven PPP loan amounts. 

CPA Jeffrey Wood of Lift Financial in South Jordan, Utah says that businesses should make sure they understand their tax liability and how it’s determined, then plan to have the funds available “even if it means drawing on a loan to make that payment.”

“In most cases, the taxable income will either be offset by deductible expenses or the forgiven loan income won’t be taxed but will be offset by non-deductible expenses and should not have any abnormal affect to the business and owners,” he says. 

If you’re not accustomed to handling your taxes on your own and you’re not sure where to start, law partner Scott Ahroni of Robinson Brog says it could be time to call in an expert.

“Work with accountants to determine the effective tax rate that would be imposed on the PPP loan forgiven to ensure that they have sufficient funds to cover the taxes due,” he says. Further, if the amounts are treated as income, consideration should be given as to whether estimated tax payments should be made. 

In such a situation, meeting the estimated tax safe harbor can help you avoid paying penalties, he says.

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