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, 2020 has undoubtedly been challenging. 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?
With tax time right around the corner, this is a pretty common concern for small business owners. 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 it all down for you, so it’s easily digestible. We’ll cover how PPP loans and EIDL advances affect your 2020 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.
How The PPP Loan Affects 2020 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 keep their 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 is owed. 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?
Do You Have To Pay Taxes On The PPP Loan?
How taxes are handled for PPP funds differs based on a number of factors. We’ll look at the different scenarios and how each will affect your 2020 tax return.
For federal tax purposes, 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. Sounds great, right? However, there is a catch, which we’ll explain in the next section.
PPP loan funds that were not forgiven are similar to other loans. Unforgiven loan funds are included as part of your taxable gross income.
The Catch: PPP Loans & Tax Deductions
The IRS issued a notice that further clarifies how PPP loan funds should be handled for 2020 income tax returns. While the forgiven funds are tax-free, expenses paid with PPP funds can’t be claimed as deductions. This means that you could have a higher tax liability once you complete your tax return.
For example, let’s say you received a $20,000 loan that you used to cover payroll. If your entire loan was forgiven, you will not be able to deduct these funds from your taxable income as you normally would. However, you would still be able to deduct any payroll that was paid with funds that didn’t come from your PPP loan.
Now, let’s say the $20,000 loan you received was not forgiven. In this case, the $20,000 is viewed as taxable income, and you can claim any relevant business deductions to lower your tax liability.
In summary, this is what you should expect from your PPP loan come tax time:
- Forgiven loan funds are not counted as taxable income but cannot be deducted from your business expenses
- Loan funds that are not forgiven are 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.
Do You Have To Pay Taxes On The EIDL Loan?
If you received the EIDL loan, taxes on these funds work like any other loan taxation. In other words, funds from the EIDL are reported as taxable business income on your tax return. However, you can lower your tax liability by deducting any expenses covered by the use of these funds.
Funds from an EIDL Advance are also reported as taxable business income. Like funding from the EIDL, 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
Businesses that received a PPP loan are ineligible to receive the Employee Retention Credit.Â
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 2020 taxes. Instead, credits can be claimed on your quarterly tax return.
If You Received A PPP Loan, Expect A Tax Audit
In recent months, 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. Make sure to 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.
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