The Paycheck Protection Program (PPP) has helped millions of small businesses maintain their payroll and pay interest on rent, utilities, and mortgages during the COVID-19 pandemic. The PPP was implemented by the Small Business Administration (SBA) with support from the Treasury Department. If you were fortunate enough to obtain one of the 5.2 million PPP loans that were given to small businesses nationwide, there are potential tax implications that you need to know about.
We are entering the final quarter of 2020, which is the perfect time to evaluate your current tax strategies and get your financial books in order. This Balboa Capital blog post explains how PPP loans might impact business taxes, and we think you will find it to be very helpful.
The ABCs of the PPP.
Before we discuss the tax-related aspects of the PPP, we want to provide you with a brief overview of the program. The PPP program is part of the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act that was passed by Congress in March, 2020. Once the PPP program was finalized by the SBA and the Treasury Department, SBA7(a) lenders were provided with all of the necessary information about the PPP program along with the official PPP application forms. Balboa Capital did not participate in the PPP program, but we delivered short term business loans to countless companies across the country.
The PPP loan amount was based on a company’s average monthly payroll costs for 2019. Business owners who were eligible could request 2.5 times that amount to pay their employees over an eight-week period. Approved lenders began accepting PPP loan applications during the first week of April, 2020, and the PPP deadline expired on August 8, 2020. More than $700 billion was authorized and over $510 billion was distributed. The average loan size in the first round of funding was $206,000, and loans in the second round averaged $120,000.
Uses of PPP loans.
PPP loans are intended to help small business owners withstand the cash flow hardships that have resulted from the COVID-19 pandemic. Keeping American workers on payroll was the driving force behind the PPP, and the program achieved this goal. The SBA reported that the PPP saved close to 51 million jobs since it launched. Workers whose employers temporarily shuttered their doors or downsized their operations were able to get money to pay bills, buy groceries, and avoid the stress that accompanies unemployment. In addition, the PPP helped stabilize the slumping economy.
A PPP loan can be forgiven (tax exempt) if at least 60% of it is used for employee payroll costs. This includes, but is not limited to, salaries, vacation pay, medical leave and health benefits. Employees must be paid at their normal levels for 24 consecutive weeks once the loan has originated. The remaining 40% of the loan can be used for PPP-eligible expenses such as mortgage interest, providing the mortgage was signed prior to February 15, 2020, and office rent, providing the office lease agreement was finalized and put into effect prior to February 15, 2020. PPP loans can also be used to pay for utilities such as electricity, water, gas, and the Internet, as long as the service for each started before February 15, 2020. Finally, a PPP loan cannot be used to pay business taxes.
When Uncle Sam visits.
As mentioned earlier, a PPP loan is exempt from taxes if it used according to the rules set forth by the SBA. For example, if you received a PPP loan of $275,000, you will not have to pay taxes on that amount. You can simply go about paying your employees and not worry about your taxable income increasing by $275,000. However, using a PPP loan can cause you to miss out on some generous tax benefits. Reason being, PPP loans are not included in your taxable income, and all of the expenses you pay for with your PPP loan are not eligible for tax deductions. So, your $275,000 PPP loan at the current 21% corporate tax rate will result in $57,750 in lost tax deductions that you would normally get. Without the deduction, you could very well end up owing more business taxes than you are accustomed to paying each year.
Some of the largest and most respected small business and accounting organizations are trying to get the IRS to change this component of the PPP. They agree that not allowing PPP expenses to be deducted could present financial challenges to small businesses that have been struggling to stay afloat this year. Nothing is set in stone, but things could change. However, just assume that your PPP expenses cannot be deducted and be prepared to pay higher taxes.
Every small business has its own unique financial situation, so we recommend that you talk to your accountant or business attorney to get the best advice and recommendations. By planning ahead, you can estimate how much in taxes you might owe, and plan accordingly.