The IRS recently released guidance saying businesses participating in the Paycheck Protection Program should refrain from deducting certain expenses from their annual tax returns. Here, you’ll learn everything you need to know about the tax consequences of accepting PPP loans from the government.
Paycheck Protection Program Basics
As part of the CARES Act, the government passed the Paycheck Protection Program to help eligible businesses continue to pay for expenses like rent, utilities, and payroll during local shutdowns. As the name suggests, one of the main goals of the PPP was to keep American workers on payroll during the COVID-19 pandemic.
The government will forgive PPP loans if a participating business satisfies certain conditions. One is that they must use at least 75% of the PPP loan to cover payroll costs during the eight-week period after loan disbursement.
Alternatively, the business may have its loan forgiven if it re-hires all of its previous full-time employees at their previous salaries. For further details regarding loan forgiveness, refer to the Small Business Administration, which is in charge of administering PPP loans.
How PPP Loans Affect Your Business’s Taxes
The government plans to forgive many of the PPP loans distributed to qualifying businesses. Traditionally, if a company has a loan forgiven, the amount of the forgiven loan counts as income. For example, if you take out a $10,000 loan, pay $7,000, and have the final $3,000 forgiven, the IRS will consider the $3,000 forgiveness as business income.
However, the Small Business Association has said businesses won’t need to count PPP loan forgiveness as income. So, if you receive a $10,000 PPP loan, comply with the requirements, and have your loan forgiven, you won’t have additional income to report.
Another thing to consider is that businesses can typically deduct expenses like rent, utilities, and payroll from their income, resulting in a lower tax liability. For example, let’s say you earn $100,000 and have payroll expenses of $30,000, rent expenses of $20,000, and utility expenses of $5,000. In this example, your taxable income would be $45,000.
However, with PPP loans, the math is a bit different. According to IRS Notice 2020-32, expenses paid with PPP money will not be deductible from a business’s income. So, if you receive a $30,000 PPP loan and use the entire amount for payroll expenses, you won’t be able to deduct the $30,000 from your tax liability.
Is IRS Notice 2020-32 Fair?
Some lawmakers (including the White House) have argued that preventing tax deductions for expenses paid using PPP money isn’t fair to business owners. However, the IRS’s position—disallowing deductions—makes sense. If a business gets tax-free loan forgiveness, it shouldn’t be able to deduct expenses paid using the tax-free loan. Otherwise, companies would be “double-dipping,” getting both a free loan and a reduced tax burden.
How to Protect Your Business
Given the current uncertainty, businesses should plan conservatively and expect to be unable to deduct expenses paid using PPP loans. If the IRS changes its mind and allows deductions, you’ll get an unexpected windfall, but it’s better to be safe than sorry.
Reach out for Help
If you’re a cannabis-related business needing help navigating your taxes in the COVID-19 era (or any time), reach out to My Cannabis Accountant. We’re a boutique accounting agency dedicated to providing cannabis accounting assistance to businesses across the United States. If you’re in need of premium accounting solutions, dispensary bookkeeping, or cannabis audit help, we’re here for you.