Is it possible to deduct business expenses paid with forgiven PPP loan proceeds?

The Internal Revenue Service refused to allow firms to deduct expenses paid with forgiven PPP loans, but Congress had other ideas

Generally, company expenses paid with tax-free government grants or loans are not deductible. Is this criterion, however, applicable to the extremely popular PPP loans?

What Are PPP Loans?

The Paycheck Protection Program was one of the most popular economic assistance initiatives launched during the COVID-19 epidemic. The Small Business Administration (SBA) provided Paycheck Protection Program (PPP) loans to millions of small firms, including many self-employed individuals (SBA).

Low-interest loans aimed to help small firms weather the COVID-19 economic collapse are known as PPP loans. For 2019 or 2020, a company with less than 500 full-time employees might borrow up to $10 million, or 2.5 times its typical monthly payroll expenditures. Self-employed people without workers might borrow up to $20,833 by borrowing 2.5 times their typical gross monthly income.

PPP loans have proven to be extremely popular. The program was expanded by Congress to include two types of loans: first-round PPP loans and second-round PPP loans for those who have previously obtained a PPP loan. Second-round PPP loans, on the other hand, were only eligible to enterprises who saw a 25% drop in gross receipts between comparable quarters in 2019 and 2020.

When the program's financing ran out in May 2021, the SBA stopped making new PPP loans.

PPP Loan Forgiveness

PPP loans are two-year loans with a 1% interest rate. But what made them so popular is that they can be forgiven by the SBA. "Forgiven" means you don't have to pay them back.

To be eligible for such forgiveness, you must submit an application to the bank or other financial institution that handled the SBA PPP loan. Businesses with employees who spent at least 60% of the PPP loan on employee payroll within the 8-week or 24-week period after receiving the loan and kept the same number of employees on their payroll qualify for forgiveness. Provided you're self-employed and don't have any workers, you may be eligible for PPP loan forgiveness if you can prove that you used the money to pay yourself as the business's owner.

Forgiven PPP Loans Not Taxable

When a lender forgives or cancels a loan, the amount forgiven becomes taxable income and must be included in the borrower's income under standard tax regulations. This is referred to as "discharge of debt" revenue. However, Congress adopted a unique tax law that exempts enterprises who obtain forgiven PPP loans from paying taxes. (Section 276(a) of the COVID-Related Tax Relief Act of 2020). A self-employed person who gets a $15,000 PPP debt forgiven, for example, does not have to include the money in their annual income.

Deducting Expenses Paid with PPP Loan Money

When you utilize tax-free government money to pay for company expenses, you are not allowed to deduct the expense from your taxes under normal circumstances. For example, a company that uses forgiven PPP loan money to pay employee salaries and rent could not deduct those expenses from its taxes under normal circumstances. This makes sense because deducting costs paid with tax-free government funds amounts to "double dipping," or benefiting twice from the forgiven loan money in terms of taxes.

Originally, the IRS intended to apply regular rules on forgiven PPP loans, making costs paid with them non-deductible. The business community and Congress, on the other hand, were outraged. As a result, Congress passed a unique tax law that allows firms to completely deduct all expenses incurred as a result of forgiven PPP loans. The IRS has completely implemented this regulation. (Ruling of the Internal Revenue Service, 2021-02).

The PPP loans aren't required to be listed on your business tax return. Furthermore, lenders who process PPP loans are not required to file a Form 1099-C with the IRS or provide a Form 1099-C to borrowers stating the forgiven amount of PPP loans.

State Tax Treatment of PPP Loans

The majority of the 42 states that have state income taxes follow the federal government's lead and do not tax PPP debts that the IRS forgives. They're also enabling state income tax deductions for business expenses paid with forgiven PPP loans.

Some states, however, have their own set of restrictions. For example, forgiven PPP loans are tax-free for all firms in California, but the expense deduction is not available for publicly traded corporations or enterprises that did not see a 25% year-over-year drop in gross revenues between 2019 and 2020. Only up to $100,000 in forgiven PPP loans is eligible for an expenditure deduction in Virginia.

​