Passage of the CARES Act in March of 2020 brought some relief for businesses struggling amidst the coronavirus pandemic. Part of the funding was aimed directly at small businesses to help them retain employees. Businesses could apply for CARES Act loans and receive much-needed assistance.
As we head into tax season and businesses look to file their 2020 tax returns, the impact of these loans becomes a real question. Are the funds received under the CARES Act taxable as income? If so, businesses could face a hefty tax bill in exchange for the economic assistance received.
Let's unravel the different provisions for businesses under the CARES Act and the tax implications for each.
CARES Act Loans for Businesses
The CARES Act quickly got money into the hands of individuals and small businesses at a time when they were really struggling. Due to quick shutdowns for health and safety reasons, many businesses were forced to close their doors and lay off employees.
In addition to direct payments to individuals and deferment on student loans, businesses also received assistance. These programs aimed to benefit both the employer and the worker.
Paycheck Protection Program Loans
The Paycheck Protection Program (PPP) provided loans to small businesses for the purpose of payroll. Administered by the Small Business Administration (SBA), businesses were eligible for PPP loans if they had under 500 employees. Businesses could apply for loans at 2.5 times their average monthly payroll costs, with a maximum loan amount of $10 million.
If the funds were spent on payroll, and the business maintained its employees at their current base pay, the business could apply for loan forgiveness. Businesses that did not meet the requirements for loan forgiveness needed to pay the loan back.
The initial $349 billion allocated for PPP loans was exhausted within two weeks. Additional legislation passed in April that added an additional $320 billion of funding. In December of 2020, the Consolidated Appropriations Act included another $284 billion for the PPP program, with applications to begin in January of 2021.
Taxation for PPP Loans
As 2020 drew to a close, businesses became increasingly concerned with the tax implications of PPP loans.
It was clear that the CARES Act excluded forgiven PPP loan proceeds from taxable income. This was a good thing; otherwise, businesses would have needed to pay taxes on the funds received.
However, the tricky question became the deductibility of expenses paid with PPP proceeds. The IRS announced that expenses paid with forgiven PPP proceeds would not be deductible.
It became something of a wash in terms of benefits to the businesses. The income was not taxable, but the expenses were then no longer deductible. In a non-pandemic year, those expenses may have otherwise been deductible, potentially leaving businesses with a higher tax burden.
Luckily, with the Consolidation Appropriations Act, Congress clarified the tax implications. The law stated that businesses that paid expenses with PPP funds could still deduct those expenses.
This was a huge win for businesses, leaving no taxable income or reduction in tax deductions as a result of a forgiven PPP loan.
Economic Injury Disaster Loans
The SBA administers financial assistance in the form of Economic Injury Disaster Loans (EIDLs). This was an existing program typically used to help businesses harmed due to natural disasters.
The CARES Act allowed businesses to apply for EIDLs if they were struggling due to the pandemic. Loan amounts of up to $2 million could be used for debts, accounts payable, payroll, and other bills.
Businesses could also request a $10,000 advance against an EIDL while waiting for the loan request's approval. This allowed businesses to quickly receive cash while the loan was being processed. If a business was later denied the EIDL, the cash advance did not need to be repaid.
Taxation for EIDLs
EIDLs are loans, just like any other loan, and have to be repaid. Therefore, they are not taxable as income.
However, the $10,000 advance that businesses received is considered a grant. That part of the loan does not need to be paid. Barring any additional ruling or guidance, businesses that received an EIDL advance will need to add that money to taxable income.
At the same time, businesses will be able to deduct expenses paid with the EIDL advance. If the money was spent on inventory, rent, and other business expenses, it would be a deduction against that taxable income.
Other Tax Implications for Businesses
The CARES Act had several other tax provisions that could impact the tax returns of businesses this season.
Payroll Tax Deferral
Businesses could opt to defer the employer's share of social security tax payments for a period of up to two years. Half of the deferred tax payable is due by December 31, 2021.
Limitations on the ability to deduct Net Operating Losses are temporarily suspended. NOLs arising in 2018, 2019, or 2020 can be carried back five years. This provides an increased tax benefit to businesses by using NOLs to offset otherwise taxable income.
Employee Retention Credits
For businesses with fewer than 500 employees that either fully or partially suspended operations due to COVID-19 or experienced a 50% decline in gross receipts could receive an employee retention credit. Businesses cannot claim the credit if they received a PPP loan.
The tax credit is a dollar-for-dollar reduction in tax liability. The calculation is per employee and is up to 50% of qualified wages up to $10,000 paid per quarter.
Prepare for Your Taxes This Season
Because of the CARES Act, your business may face more complex tax preparation than years past. You want to make sure that you properly account for CARES Act loans and either pay the necessary taxes or don't pay more than you should.
An experienced tax professional will know how to handle even the most complicated of IRS rulings. Your tax preparer should know how to apply the guidance provided for CARES Act Loans to your tax returns.
At The Law Office of Katie Lawson, we focus on tax law. If you need tax resolution with the IRS, we are here to help. Book a consultation online today.