Many different forms of financial aid were developed to help taxpayers and business owners during the pandemic. One of the most popular forms of relief, is the Paycheck Protection Program (PPP), which is a loan program offered by the Small Business Administration (SBA) meant to help employers retain and pay their employees.
In December 2020, the Consolidated Appropriations Act, 2021 (CAA 2021) was signed into law, which extended the program through March 31, 2021, and required the SBA to publish clearer implementing guidance on the loan’s eligibility and taxation.
Federal and state tax treatments of PPP loans and their forgiveness can be different. It’s important for taxpayers to be informed on the new guidance provided by the SBA regarding the Second Draw PPP loans and also understand how these loans will affect their taxes.
Here are the updates you need to know:
Second Draw PPP Loans
The SBA is accepting applications until March 31, 2021. Businesses who received a loan under the first PPP program, may qualify for a Second Draw PPP loan. Borrowers are generally eligible if:
- They’ve received a First Draw PPP loan and will use, or have used, the full amount only for authorized uses.
- They employ 300 or fewer employees.
- They can demonstrate at least a 25 percent reduction in gross receipts between comparable quarters in 2019 and 2020.
- Their business was in operation on Feb. 15, 2020, and is not a publicly traded company.
Here’s the Paycheck Protection Program Second Draw Loan Borrower Application Form on the SBA’s website.
Federal and State Tax Treatment of PPP Loans
It is important for taxpayers to carefully consider their state’s tax treatment of PPP loans and what it means for them if their loan is forgiven. States respond to PPP loan forgiveness and expenses differently.
Federally, covered expenses paid with PPP funds can be deducted and forgiven PPP loan amounts will not be counted as gross income. Whether a borrower’s PPP loan forgiveness is taxable at the state level depends on the state’s conformity rules.
North Carolina, for example, has already passed legislation and guidance on PPP loan forgiveness and expenses and how it will affect taxpayers. The state will not include the amount of forgiven PPP loan in an individual’s or corporation’s taxable income. However, any expenses paid using the proceeds of the PPP loan that are deducted for federal tax purposes are not able to be deducted when calculating North Carolina taxable income.
Potential PPP Loan Tax Issues
The deductibility of PPP-funded expenses may cause some tax consequences for PPP loan recipients and taxpayers should be aware that tax deductions for expenses paid using PPP loan proceeds may require some additional tax planning.
Typically, cancellation of debt reduces tax attributes, which are economic benefits such as tax credits or depreciable assets; however, this is not the case with PPP loans.
If the tax deductions and cancellation of debt occur in different years (2020 and 2021), this can cause a business owners’ distributions and/or losses to be more than their stock’s tax basis.
This is a problem because then the taxpayer’s distributions are treated as taxable income and/or can create suspended losses, which are not deductible until the business owners have increased their stock basis and/or debt basis, by putting cash into the company in the form of profit, additional paid in capital, a personal loan, etc.
Remember, for S Corporations, specifically, PPP loans do not count towards increasing your shareholder stock’s tax basis. The Internal Revenue Service does not allow third party debt, such as a PPP loan, to count toward tax basis that taxpayers can then use to take distributions.
PPP loan forgiveness will likely increase an S corporation’s other adjustments account (OAA), which will limit the amount of distributions to shareholders that may be a tax-free, because such distributions are restricted by the amount of the accumulated adjustments account (AAA).
Whether you’re a small business in the middle of tax planning or an entrepreneur needing to pay estimated taxes, it’s important to know and understand your federal and state’s tax treatment of PPP loans.
Contact Anthony Hoffmaster, CPA, CES, MST, with questions about the new provisions of PPP loans and how they may affect your federal or state taxes. You can reach him by phone 919-435-4413 or email.