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Detail the tax implications of PPP loans

By on March 23, 2021 0

The approaching tax season raises new questions for business owners who have obtained a loan under the Paycheck Protection Program.

Can you deduct expenses paid with your loan funds? Do you need to do something different this year? And if your loan is cancelled, is this considered taxable income?

The answers to these questions have been difficult to find, in part due to changing IRS guidelines. But new rules set out in the latest round of coronavirus relief help end the confusion.

“Doing your taxes wasn’t easy before COVID,” says Keith Hall, president and CEO of the National Association of the Self-Employed. “The good news is that this year won’t be any harder than any tax returns you’ve had in the past.”

Canceled PPP loans are not taxable

“Historically and forever, if you have a business loan and it’s forgiven, that’s automatically taxable income. It’s been part of the tax code forever,” Hall says.

Paycheck Protection Program loans break this code. Congress clarified, and the IRS clarified, that canceled PPP loans will not count as income. This applies whether your entire loan is canceled or only part of it.

“If he is pardoned, it will not be taxable income. Period,” Hall says.

You can deduct expenses paid with a PPP loan

This one has been more of a moving target. Initially, the IRS position was that expenses paid with PPP loan funds cannot be deducted if the loan has been or will be forgiven.

However, this changed with the Coronavirus Relief Act enacted on December 27, 2020, which clarifies that deductions should not be disallowed simply because of loan cancellation.

This means that expenses paid with your PPP loan are deductible.

This result effectively creates two layers of tax advantages for PPP loan recipients, says Roshani Pandey, financial adviser and founder of True Root Financial in San Francisco.

“The first benefit is to make the loan income tax-exempt,” says Pandey. “The second allows businesses to claim income deductions on expenses paid.”

Business taxes are not a permitted use of PPP funds

The latest round of coronavirus relief also gives business owners more flexibility in how they spend PPP funds. Newly covered costs include protective gear, hardware damage, and business software.

Business taxes are not part of this extended list. Thus, if you use your PPP loan to pay your business taxes, this amount will not be returned to you.

You can still claim the employee retention tax credit

Businesses can now claim the employee retention tax credit if they qualify. There is an important caveat: you cannot reclaim wages paid with a canceled PPP loan.

However, you can claim the credit on wages paid in excess of the amount remitted.

To be eligible for the tax credit, you must continue to pay employees despite a temporary closure due to COVID-19 restrictions or a 20% drop in gross receipts from the same quarter of the previous year.

These changes were introduced with the Coronavirus Relief Bill on December 27, 2020, but are retroactive to March 12, 2020. The credit is valid on qualified wages paid through July 1, 2021.

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Kelsey Sheehy writes for NerdWallet. Email: [email protected]