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Round 2 of the Paycheck Protection Program (PPP) opened last week. If you receive a loan in 2021 or received a loan in 2020, you should be aware of the tax consequences.
Information on CARES Act (Round 1) and Consolidated Appropriations Act (Round 2)
In March of 2020, the CARES Act became law. It authorized the Small Business Administration (SBA) to make loans to qualified businesses under certain circumstances. The law established the PPP, which provided up to 24 weeks of cash-flow assistance through 100% federally guaranteed loans to eligible recipients. Taxpayers could apply to have the loans forgiven to the extent their proceeds were used to maintain payroll during the COVID-19 pandemic and cover certain other expenses.
At the end of 2020, the Consolidated Appropriations Act (CAA) was enacted. This law provides additional relief with funding for more PPP loans, including a “second draw” for businesses that received a loan last year. It also clarified that companies could claim a tax deduction for the ordinary and necessary expenses paid from PPP loans’ proceeds.
Qualification and forgiveness for second draw loans
The CAA permits smaller businesses who received a PPP loan and experienced a 25% reduction in gross receipts to take a PPP second draw loan of up to $2 million.
To qualify for a second draw loan, prior PPP borrowers must meet the following conditions to be eligible:
- Employ no more than 300 employees per location,
- Have used or will use the full amount of their first PPP loan, and
- Demonstrate at least a 25% reduction in gross receipts in the first, second, or third quarter of 2020 relative to the same 2019 quarter. Applications submitted on or after Jan. 1, 2021, are eligible to utilize the gross receipts from the fourth quarter of 2020.
To be eligible for full PPP loan forgiveness, a business must generally spend at least 60% of the loan proceeds on qualifying payroll costs (including certain health care plan costs) and the remaining 40% on other qualifying expenses. These include mortgage interest, rent, utilities, eligible operations expenditures, supplier costs, worker personal protective equipment, and other eligible expenses to comply with COVID-19 health and safety guidelines or equivalent state and local guidelines.
Eligible entities include for-profit businesses, certain non-profit organizations, housing cooperatives, veterans’ organizations, tribal businesses, self-employed individuals, sole proprietors, independent contractors, and small agricultural co-operatives.
Are expenses paid with PPP loan proceeds deductible?
The CARES Act did not address whether expenses paid with PPP loans’ proceeds could be deducted on tax returns. Last year, the IRS took the position that these expenses weren’t deductible. However, the CAA provides that expenses paid from the proceeds of PPP loans are deductible.
Cancellation of debt income
Generally, when a lender reduces or cancels debt, it results in the cancellation of debt (COD) income to the debtor. However, the forgiveness of PPP debt is excluded from gross income. Your tax attributes (net operating losses, credits, capital and passive activity loss carryovers, and basis) wouldn’t generally be reduced on account of this exclusion.
We’re here to help
This article only covers the basics of applying for PPP loans, as well as the tax implications. If you have questions about the information outlined above or need assistance with a tax or accounting issue, JLK Rosenberger can help. For additional information, call us at 949-860-9902 or click here to contact us. We look forward to speaking with you soon.