How Do PPP Loans Impact Business Taxes?

Can businesses claim tax deductions for business expenses under the Payment Protection Program (PPP)? Is a PPP loan considered taxable income? Here are your tax questions, answered.

Key takeaways

  • Business expenses associated with PPP loan forgiveness are deductible
  • Forgiven PPP loans are not considered taxable income
  • Payroll taxes can be deferred, even after PPP loans are forgiven
  • Employers can take advantage of the Employee Retention Tax Credit and PPP loans

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was introduced in March 2020 to assist American businesses and individuals struggling financially. 

Part of the CARES Act was the creation of the Paycheck Protection Program (PPP), which provided businesses with loans that would be forgiven if they complied with all requirements, including using the loans for qualified business expenses. PPP loans are just one form of relief for businesses impacted by the pandemic, which has caused record closures, layoffs, and unemployment claims over the last year.

Since March 2020, there have been many questions circulating about PPP loans and what they mean for business expense deductions and taxes in general. As a new relief bill was passed at the end of 2020—the Consolidated Appropriations Act of 2021—some of these questions were answered, and common issues were clarified. 

Let’s walk through what you need to know about business expenses and whether they’re deductible, whether a forgiven PPP loan is considered taxable income, payroll taxes and PPP, and other important information about the program.

Business expense deductions

The CARES Act did not directly address whether business expenses covered as part of the loan-forgiveness process would be deductible. But in April 2020, the IRS said that no deduction would be allowable for expenditures that were otherwise deductible if the expense payment results in PPP loan forgiveness. 

In November, the IRS also said that a taxpayer calculating taxable income could not deduct eligible expenses in 2020 if they had reason to expect reimbursement in the form of loan forgiveness based on qualified business expenses paid during the period.

However, the second relief bill passed in late December 2020 clarified that deductions are allowable for the otherwise deductible business expenses paid with a forgiven PPP loan. It also explained that the tax basis and other attributes of the borrower’s assets would not be reduced because of loan forgiveness.

Another piece of good news is that this new clarifying provision is effective dating back to when the CARES Act was first enacted. The second round of PPP loans, which the new relief bill also authorized, will be treated similarly.

Not all business expenses are included as part of PPP loan forgiveness. Note that the PPP loan funds cannot be used to pay business taxes, for example. Eligible expenses include: 

  • Payroll costs
  • Rent 
  • Mortgage interest
  • Utilities payments
  • PPE and worker protection expenses
  • Business software and other operational expenses
  • Certain property damage costs
  • Supplier expenses

As long as at least 60% of the PPP loan was used for payroll expenses and the remaining 40% was used for these other qualified expenses, the loan will be eligible for complete forgiveness. 

PPP loan as taxable income

The CARES Act excluded PPP loan forgiveness from a borrower’s gross income, meaning that businesses didn’t have to pay taxes on the funds received. Lawmakers did not want to add an additional tax burden for companies that were already struggling.

The December 2020 bill reestablished that a forgiven PPP loan is not taxable income and is completely tax-exempt. 

Payroll taxes and PPP

Another vital thing to know is that employers can defer payroll taxes even after the PPP loan is forgiven. But half of the deferred payroll taxes from 2020 must be paid by the end of 2021, and half must be paid by the end of 2022.

The PPP Flexibility Act clarified these rules in June of 2020, in addition to changing the maturity period of the loans to a minimum of five years and extending other PPP-related deadlines.

Other PPP tax implications

The second relief bill included a provision that businesses taking out a PPP loan can also obtain the Employee Retention Tax Credit (ERTC) for both 2020 and 2021 tax years. So, a company can apply the ERTC for 2020 taxes. However, note that the ERTC and PPP loan cannot cover the same payroll expenses.

The ERTC is available to businesses with under 500 employees that either had to suspend or partially suspend operations because of a COVID-19-related court order or had a 20% decline in gross receipts when compared with the same period the year before.

The tax credit was 50% of up to $10,000 in wages for 2020, but the new bill expanded the ERTC from a maximum of $5,000 per employee to $14,000 per employee beginning January 1, 2021, and through June 30, 2021. 

Receiving a PPP loan also does not get in the way of the business receiving family and sick leave tax credits under the Families First Coronavirus Response Act (FFCRA). Companies cannot use the loan funds to pay for the sick and family leave wages, however, if they expect to get the tax credit.

Work with a tax expert for additional assistance

If you still have questions about how PPP loans could impact your taxes this year, contact a tax professional who can help you make sense of the changing laws and regulations. You never want to make a mistake on your tax return or leave money on the table. The professionals at Provident CPA & Business Advisors specialize in tax minimization, and we work with a variety of individuals and business owners.

Contact Provident to meet with an expert about PPP loan implications and how best to prepare your taxes.

How to Avoid Overpaying Tax on Mutual Funds

Mutual funds can be taxefficient investments – that is, as long as you are aware of the strategies necessary to avoid overpaying the IRS

Investing in mutual funds is a way for investors to pool security ownership with other investors. But when you’re considering taking advantage of the benefits of mutual funds, make sure you don’t overpay in taxes. Here are certain funds to consider and behavior strategies to follow that will ensure you maintain tax-efficient investments:

Tax-efficient funds

First, let’s look at index funds. This type of mutual fund passively matches or tracks a market fund, such as the S&P 500. But unlike actively managed funds, therules and selections don’t change based on what the market does. Not investing directly in the market has many benefits, such as low operating costs and low portfolio turnover. Because of this low turnover, these investments are tax efficient and less expensive to manage than actively managed funds, which investors frequently buy and sell. Plus, index funds are diverse, so your funds are spread out and betterprotected from big losses.

An exchange-traded fund (ETF) is a type of index fund which trades on a major stock market, like the New York Stock Exchange. ETFs are generally investments with lower risk and lower costs, and are bought and sold throughout the day like stocks, meaning investors can place different types of orders. (Mutual funds, on the other hand, settle when the market closes.) Costs are lower because there’s no sales load, though you will pay commissions. But the better tax efficiency comes from investors being able to control when the capital gains tax is paid.

Another type of tax-efficient mutual fund is a tax-managed fund. These funds help reduce the amount of capital gains tax you pay by harvesting losses to offset gains. You see capital gains either by selling shares or by receiving embedded gains, which happen when the fund sees a gain from the sale of a share and that gain is passed to you as share holder. Tax-managed funds aim to reduce that second type of gain that you’ll have to pay tax on, whether by harvesting losses (mentioned above), avoiding turnover, or selling certain shares to minimize taxable gains.

Basically, you control when you realize your capital gains. And in some instances, thesefunds may have early-redemption fees that deter withdrawals which could forcemanagers to sell and thus see capital gains.

The last type of investment worth mentioning is a separately managed account (SMA). These accounts differ from mutual funds in that you have an account manager who directs securities that you own on your behalf. SMAs can help you avoid turnover and you may see opportunities to take advantage of tax swaps. Just keep in mind that the fees on SMAs could be a bit higher than mutual funds.

Tax-efficient behavior

You want to ensure that your investment behavior actually takes advantage of the tax benefits you can see from the above types of funds. Many investors don’t fully understand the tax implications of mutual funds, The New York Times notes.

First, try to avoid large lump-sum distributions. For tax-deferred accounts, like retirement accounts, you’ll see a big tax bill if you opt for one large lump-sum withdrawal. Instead, try rolling the money over or spreading out the distributions over several years.

Also try to limit the amount of turnover on your mutual funds. When you trade frequently, the capital gains you see may be subjected to high income-tax rates, instead of better long-term capital gains tax rates.

When applicable, try tax loss harvesting, or tax swaps. This strategy allows you to use capital losses (when you sell a fund for less than you bought it) to offset any capital gains. This can help you reduce or manage your tax bill from capital gains.

Keeping dividend payout timing in mind is another important strategy to manage taxes. The capital gains you accrue throughout the year are paid out as the end of the year is nearing. Avoid buying shares right before that happens, since you’ll have to pay taxes on gains before you may see any profit from the shares. In contrast, selling shares before the dividend date can help you avoid overpaying on tax by avoiding higher ordinary income tax rates versus capital gains tax rates.

When you’re ready to look at your investment portfolio with an experienced financial professional, Provident CPA andBusiness Advisors is here to help. We ensure you pay the least tax legally possible and help you create a diverse and balanced investment portfolio. Get in touch with our team today to learn about how we help our clients create investment strategies that work.