How to know if you owe taxes on your PPP loans
- If you received a PPP loan for your business, your state’s tax bill may seem higher than you expected.
- 11 states have waived the tax on P3 funds, including California, Florida, and Texas.
- Experts suggested keeping backup data on how the funds were spent and forgiven.
- See more stories on the Insider business page.
Tax deadlines can be confusing and vary depending on the classification of businesses.
S-corps, multi-member LLCs, and flow-through entities are expected to have filed 2020 tax returns by April 15. But if you file your business taxes as part of your personal return, you can have until May 17 to file.
One thing that many small businesses in the United States have in common this year is that those who received funding through the Small Business Association’s Paycheck Protection Program (PPP) or other grant programs and loans to help businesses stay afloat during COVID-19 may be in for a stunning state tax bill as they get back on their feet. This is because some states have decided to deviate from the federal government’s decision to waive tax on pardoned P3 funds.
How to know if you are going to owe your state on PPP loans
11 states listed by the Tax Foundation, including California, Florida, Hawaii, Minnesota, Nevada, New Hampshire, North Carolina, Texas, Utah, Vermont, and Virginia, have exempt PPP funds tax.
In Ohio and Washington, they are generally not taxable because of the way state tax policies are put in place. However, even this is not final: in some of these states, legislation to make changes to this situation is currently on the table.
North Carolina House, for example, has already approved a bill to align the state’s tax code on pardoned P3 funds with that on federal tax remission. The bill now sits in the state Senate, and once passed, it will go to the governor to be signed into law. Companies operating in North Carolina that have forgiven funds on their books will either have to file an extension to wait for the bill to be ratified, or if they have already filed and have forgiven funds on their books, file an amended return for benefit. of change – assuming it happens.
Eileen Sherr, director of tax policy and advocacy at the Association of International Certified Professional Accountants, told Insider that companies with forgiven PPP funds that have doubts about their states’ reputations should seek an extension if possible.
If you are wondering how these tax policies impact the financing of Economic Impact Lending (EIDL), Nick Kolbenschlag, CEO of Charlotte, NC’s Crown Wealth Group, told Insider that these funds are taxable, as are canceled PPP loan funds. in the states listed above. He also said that funds received through state, local or private grants are taxable at the federal and local level.
“Because these funds were not tied to the CARES Act or any of the federal laws that underpin it, they are considered free money and it’s taxable,” he said. . “This has the potential to be a mess, especially if you are a very small business.”
While this is the most impactful area where state governments have failed to comply with federal regulations in all areas, there are other smaller schisms as well.
“In December, the federal government decreed that the loan fees would be deductible, and states had some policy issues as to whether they would follow that as well,” Sherr said.
Making sure you are producing correctly is all about the proper classification of your funds.
In accounting, PPP loans are treated like conventional loans – until canceled.
When a company obtains a conventional loan, it is applied to the liabilities of the company’s balance sheet. When the loan is paid off, the business can take the interest as a deduction and it is removed from the business’s balance sheet. If a conventional loan is canceled, it is considered a forgiveness of debt income and should be recorded as “other income” on your income statement, Kolbenschlag said.
PPP loans are tracked on the liability side of the balance sheet, and when canceled most accounting systems are triggered to convert funds into income – but that’s incorrect.
“When a PPP loan is canceled, the situation is different,” Kolbenschlag told Insider. “It would be considered taxable income in the normal world and is taxed as profit. But when the accountant or CPA goes that route, QuickBooks puts it in an income account and declares it to be income. taxable. PPP loans must be separated manually. that profit figures are not inflated and these companies do not end up looking at unreasonable tax bills. “
Kolbenschlag suggested that companies rename the income account where PPP funds reside to “Debt forgiven income” and specifically state that they are tax-free PPP funds to ensure that the accountant who prepares the return understands exactly what these amounts are and knows they are not. taxable.
Although the Kolbenschlag firm does not prepare tax returns for its clients, he has done quite a bit of advice to make sure the business owners he works with don’t come back with a “sticker shock” when they do. see how much they owe. He said he saw PPP funds end up on the company’s balance sheet, artificially inflating its income and therefore its tax bill.
Then there is the issue of state taxation of remitted funds, which is different from federal taxation, which can have significant repercussions.
“It has the potential to be a big mess, especially if nobody explains it to you,” Kolbenschlag said. “I have a client who, among all their businesses, had about $ 1.3 million in PPP loans – that’s a huge amount of state tax that they might not have been prepared for if we hadn’t already had this conversation about it. . “
Kolbenschlag, who has worked with companies throughout the PPP process, also stressed the importance of having all of your backup documentation – for the loan process and the forgiveness process – organized and ready, just in case. would be necessary.
The potential for being called upon to present this documentation is very low, he said, but if you are asked to “show your work,” you don’t want to fall out when the IRS comes calling you. Cloud-based integrated accounting and payroll software packages make it easy for smaller businesses to print reports on demand and keep up to date with financial data at all times, Kolbenschlag added.
What to do if you think you’ve filed an incorrect return or if your state’s laws change
Kolbenschlag initially advised business owners to invest in expert help.
“This year, more than any other year, it’s very prudent if you’re a small business owner to have a good CPA who handles your taxes and understands how all of these things work together,” he said. . It could be the difference between a smooth experience that ends with a smaller bill and a difficult experience that wastes time and money.
“Keep in mind that you can always change your return,” Sherr added, if you file now and additional state or IRS guidance will be issued later.
For other businesses that have received funding in subsequent cycles, this issue may not affect the taxes they produce that year.
“It might not be a tax issue for 2020 for many businesses – it could become a tax issue for 2021 for people,” Kolbenschlag said. “Potentially by the spring of 2022, when you file your taxes, your business will be in better shape by then (to absorb all applicable state tax bills) or the law will have changed in your favor.”
Sherr also advocated for companies to carefully keep their backup data documenting how PPP funds were spent and to be ready not only in the event of a change in laws, but also in the event of an audit.