Did you know that expenses paid with a Paycheck Protection Program (PPP) loan can be deducted on your taxes, even if that loan is forgiven? This is an important factor for small business owners to know and can reduce your tax requirements.
Note that answers to tax questions have been hard to determine, in part due to the lack of updated guidance from the IRS. Thankfully the new rules, spelled out in the latest round of coronavirus relief, can clear up some of the confusion.
Forgiven PPP loans are not taxable
Historically, if you had a forgiven business loan, it used to be automatically taxable income based on long-time internal revenue codes.
Now, however, Paycheck Protection Program loans break from that code. Congress specified, and the IRS clarified, that forgiven PPP loans will not count as income. This applies whether your entire loan is forgiven or just a portion of it.
You can deduct expenses paid with a PPP loan
Initially, the IRS’ rules were this: Expenses paid with PPP loan funds can't be deducted if the loan was or will be forgiven.
However, that changed with the December 27, 2021 coronavirus relief act, which states that deductions shouldn't be denied because the PPP loan is forgiven.
Deductible expenses paid with your PPP loan now include:
- Payroll costs or individual salaries
- Insurance benefits
- Employee salaries and/or commissions
- Rent payments and/or mortgage payments
- Utilities
- Software or cloud computing costs for business operations
- Costs related to property damage and vandalism or looting due to public disturbances not covered by insurance or other compensation
- Costs of the supply of goods that are essential to business operations
- Covered worker protection expenditures that help adapt business activities to COVID safety requirements
Businesses typically spend PPP funding in about 10 weeks.
If you reduce your full-time employee count or employee wages after the 8-week period, that might reduce your eligible forgiveness amounts. However, a longer, 24-week covered period gives you more time to remedy any reductions in employee count or wages.
Business taxes are not an allowable use of PPP funds
The latest round of financial relief also gives business owners more flexibility when spending PPP funds. Business taxes aren't on that list. If you use your PPP loan to pay business taxes, that amount will not be forgiven.
You can still claim the Employee Retention Tax Credit. Businesses can now claim this credit if they meet the outlined requirements.
However, you cannot claim wages paid with a forgiven PPP loan. However, you can claim the credit on wages paid above and beyond the amount forgiven.
To qualify you must:
- Continue to pay employees despite being temporarily shut down because of COVID-19 restrictions
- Your business is suffering a 20% drop in gross receipts compared with the same quarter in the prior year.
These changes are retroactive to March 12, 2020 and are good for qualified wages paid up to July 1, 2021.
Consult with a tax professional ASAP
Most small business owners are not tax experts. An accountant with a tax specialty can help guide you so you can maximize tax strategies. The timing of using the credits in relation to your PPP forgiveness period can yield significant additional benefits if done properly. Here’s information to help you choose the right tax professional: How to Find an Accountant for Your Small Business. The services offered by your accountant can also include:
- Setting up financial systems and processes
- Maintaining financial records
- Tax planning, preparation and filing
- Business book auditing/preparation for an outside audit
- Handling payroll to ensure that employees tax codes and payments are correct
- Helping you prepare the necessary documentation to complete an application for outside funding
