How Will PPP Loans & EIDL Advances Affect My State & Federal Taxes?
PPP loans aren't taxable at the federal level, but state tax implications vary
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.
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.
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.
Which States Are Taxing PPP Loans?
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
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.