Small businesses may be looking at an unwelcome surprise with tax time upon us. You might have to pay taxes on your Paycheck Protection Program (PPP) loans, which were supposed to help your business survive but could now create an extra financial burden for you.
To be clear, you do not have to pay federal taxes on your PPP loans. And that’s unusual when it comes to federal government loans. Since the PPP loans can be forgiven (and there is more information on PPP loan forgiveness here), they count as “forgiven debt.” And forgiven debt is generally considered taxable income.
But when Congress passed the first COVID-19 relief bill, the CARES Act, in March 2020, they didn’t address taxation of PPP loans. The IRS later decided PPP loans would not be taxed by the federal government, which Congress made official in the most recent bill.
The loans were meant to infuse cash flow and keep employees on the payroll as a “very few strings attached” lifeline to keep small businesses open through a very difficult 2020. But PPP loans can still be considered taxable income by the states. And some states are sticking a significant tax bill on those PPP loan amounts, putting a big financial strain back on small businesses that took the loans.
Some states argue that if small owners don’t pay taxes on PPP loans, they would lose billions in revenue while their budgets are back in deficit territory. Other states are scrambling to try to undo those PPP loan tax laws, even as businesses are already preparing their taxes.
There are 19 states still charging taxes on PPP loans, either by including them as taxable income or by not allowing businesses to deduct the expenses for costs they took on because of the loans.
Many state budget officials defend charging taxes on PPP loans, even as the economy has not yet fully recovered.
The Virginian-Pilot reports on why that state is taxing PPP loans. The short answer is that taxing those loans represents more than $100 million in revenue for the state this year alone.
“Not only was it a significant revenue impact,” Virginia Secretary of Finance Aubrey Layne told the state General Assembly, but the state’s potential losses of more than $100 million this year and hundreds of millions more in the years to come “were not good for most Virginians.”
Proponents of taxing PPP loans do have some strong arguments. Some businesses that deserved the loans did not get them, so they get a double-penalty of missing out on both the loan and the tax cut. Some businesses got PPP loans when in some cases, they really didn’t deserve them. And loan forgiveness takes hundreds of millions in tax dollars away from other badly needed relief measures.
But to many legislators and small businesses, those taxes are an unacceptable burden on businesses that still have urgent financial problems and uncertainties. In Massachusetts, which is also planning to tax PPP loans, the state director of the National Federation of Independent Business Christopher Carlozzi excoriated these tax charges in an Eagle-Tribune op-ed piece.
“After a financial and emotional roller coaster ride of closing, reopening, rollbacks, capacity limits, and restrictions, small businesses that file their taxes as pass-through entities will now be forced to pay state taxes on their forgiven PPP loans,” Carlozzi wrote. “The funds were designed to save small businesses and jobs and to prevent the permanent closure of the shops and restaurants that make up Massachusetts’ Main Streets. They were not supposed to be a funding mechanism to fill state coffers with revenue.”
Some of the states that have approved taxes on PPP loans are considering backtracking on the decision. Virginia is now considering bills that would allow tax deductions on forgiven expenditures up to somewhere between $25,000 and $100,000. The Massachusetts state senate is trying to push a bill through that would eliminate all PPP loan taxes on small businesses.
But some states are coming up with other clever ways to offset the tax burden. In the state of New York, The Center Square reports the New York state assembly is considering a bill that would give small businesses a tax credit of up to $5,000 if they’ve invested resources on making their business safer from COVID-19. That would provide direct relief to struggling small businesses and give incentives for businesses to install Plexiglas shields between tables or staff at cashier counters, signage to promote social distancing and safety, and those temperature checking devices so many businesses are now using.
But the clock is ticking quickly on all of these tax relief measures. After all, it’s already tax time for last year’s returns. Legislation moves slowly, and these bills may not cross the finish line by the 2021 Tax Day of April 15. The IRS is currently not considering extending that deadline this year like they did in 2020.
If your business is in South Dakota or Wyoming, as you likely already know, the state income tax on your PPP loans is not a concern for you. There is no state income tax in either state.
But if your state is one of those charging taxes on PPP loans, you may really need some extra bookkeeping help. Your small business could be looking at the enormous headache of having to create 2 completely different sets of 2020 taxes—one set of federal taxes where your PPP loans are not taxed and the state taxes where you are taxed on your PPP loan.