While most Paycheck Protection Program (PPP) loans won't be subject to federal taxes, some states may still tax them.
Late last year, Congress passed The Consolidated Appropriations Act of 2021, which made loans funded through the Paycheck Protection Program (PPP) tax-deductible. The legislation allows businesses to write off a slew of expenses, including payroll, rent, utilities, software/ IT, and property renovations or modifications.
On the state level, small businesses may or may not be able to deduct PPP loans.
State Filing Requirements May Differ From Feds
While the legislation provided guidance and added clarity regarding federal taxation, small business owners should be aware those guidelines may not apply to individual states.
"They may still be taxed by the state, depending on what states do. Some states conform automatically, and many don't," warns tax strategist Tom Wheelwright, founder of WealthAbility in Tempe, Ariz. "We certainly would expect them to be taxed in California, for example, but we won't know about states like Arizona until the legislature discusses conformity this year."
Typically for income tax, states mirror the federal return, according to Suzanne Weathers, owner of Weathers & Associates Consulting in Spokane, Wash.
"However, there are states, cities and/or regional and special treatment taxes which businesses have a reporting requirement," she says. "These are usually based on gross revenue/receipt income but not grant income."
Attorney and entrepreneur Ashley Morgan wants PPP recipients to remember that some COVID relief funding follows other disclosure and compliance rules.
"Many grants given out by state and local governments will likely be taxable," says the owner of Herndon, Va.-based Ashley F. Morgan Law PC, which primarily serves business clients in bankruptcy or facing other debt issues.
Last year, a PPP loan helped her Northern Virginia law firm cover two months of payroll during a particularly slow business period.
Track Expenses and Other Important Docs
Wealth manager Syed Nishat advises PPP loan recipients to contact their lender for the new shortened, one-page forgiveness form and track eligible expenses and documentation over the 24-week eligibility period.
While some lenders will have additional requests, the SBA requires the following documents:
- Utility, rent, and interest payments. May include receipts, statements, and canceled checks.
- Employment and pay rates during PPP coverage. Could include payroll tax filings (Form 941), payroll reports from a payroll provider, and documents verifying health insurance and retirement contributions.
- Income. Includes unemployment insurance and state payroll filings.
- Full financial statements for end of fiscal year.
"Good recordkeeping is vital to ensuring that you have everything in hand to provide when you apply for loan forgiveness," says Nishat, a partner at Wall Street Alliance Group in New York City. "Both the SBA and the lender may audit a business's financial records, so it's in an employer's best interest to make sure everything is kept neat and up-to-date for easy review."
More Changes Likely on the Way
Indianapolis-based Delta Wealth Advisors has helped more than 50 clients across the country secure PPP loans, with nary a rejection.
Partner Niko Finnigan is advising clients and other PPP recipients to take this important step regarding forgiveness.
"If they have not yet applied for forgiveness for PPP round one, do not apply for forgiveness until they receive PPP two funding," says Finnigan, who's based in the Chicago suburbs.
While many of the initial concerns regarding taxation and expense deductions following the first round of loans were addressed in the follow-up legislation, small businesses can expect to see more changes or updates in the coming months.
According to Finnigan, the first round of PPP loans included more than 14 amendments.
"We've seen multiple amendments on this round," he cautions. "There will be additional amendments for sure."