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Businesses buoyed by coronavirus relief funding may face a new wave of uncertainty this tax filing season as rules about how that money should be reported on federal and state income taxes continue to shift.
Congress made coronavirus relief programs like the Paycheck Protection Program and the Shuttered Venue Operators Grant tax-exempt, while still allowing companies to deduct business expenses paid with the funds they received, effectively creating two layers of tax relief for struggling businesses.
But, not all states followed suit — and many have been inconsistent with the tax treatment of COVID-19 funding at the state level — causing confusion for businesses owners.
Here's how various types of COVID relief funding may impact your 2021 business taxes. When in doubt, consult with a tax professional to decode any changes or nuances in your state’s tax code.
Paycheck Protection Program
Forgiven PPP loans aren't taxable income as far as the IRS is concerned. And expenses that normally would be deductible are still deductible, even when paid with a PPP loan. But some states deviate from the federal code on one or both of these points.
In Utah, for example, forgiven PPP loans are considered taxable income on state returns. And in California, only private companies that experienced a 25% drop in gross receipts can deduct expenses paid with a PPP loan.
Other states altered their tax treatment of PPP loans and expenses in 2021, meaning businesses may need to file amended returns.
COVID-19 Economic Injury Disaster Loans
Funds lent through the Small Business Administration’s EIDL program aren't taxed as income, says Armine Alajian, a certified public accountant and founder of the Alajian Group, an accounting firm with offices in Los Angeles and New York.
“EIDL loans are pure loans paid in 30 years at 3.75% interest. This is not taxable because it's not income, it's a loan to pay back,” Alajian says. “The payments are not tax-deductible either.”
Businesses that received a targeted or supplemental EIDL advance don't need to report those funds as income for federal tax purposes either. While those funds are technically grants, they are excluded from taxable income.
State and federal COVID Grants
Grants are typically treated as income on business tax returns. That’s not the case with two large-scale federal COVID grants: the Shuttered Venue Operators Grant and the Restaurant Revitalization Fund.
Money received through either program isn't taxed as income on federal returns, and you can deduct expenses paid with your grant money. You may need to report these funds on your state taxes, though, as some states don’t align with the federal government on this.
State grants are a different story. These funds are often considered income on both state and federal returns, but some states have made exceptions for COVID-relief grants.
If you’re unclear on your state’s rules, check your tax documents and consult a tax professional, says Talibah Bayles, founder and CEO of Birmingham, Alabama-based TMB Tax & Financial Services.
“Be very intentional about looking at any 1099s you receive due to a grant,” Bayles says. That form will indicate if the grant is taxable. “If you have a 1099 and it is taxable, talk to a tax professional. What were the program requirements? Are there any nuances at the state level that would allow you to treat it as not taxable on the federal level?”
Employee Retention Credit
The Employee Retention Credit has gone through several iterations over the past two years, causing headaches and heartburn for many small-business owners.
Originally, business owners couldn’t double-dip on PPP and ERC. This was later amended, retroactively, so businesses that took out a PPP loan could claim the tax credit, just not on wages already covered by their PPP loan.
The amount of the credit also changed. Businesses could qualify for up to $5,000 per employee for wages paid between March 12, 2020, through the end of 2021. That figure changed to $7,000 per employee, per quarter, for wages paid from Jan. 1 through Sept. 30, 2021, making it a much more enticing option for small-business owners.
“I do think it is a gem for business owners," Bayles says. "It’s a great opportunity for trying to positively impact your cash flow.”
The problem: Most small businesses don’t have payroll.
“Especially your solopreneurs or even single-member LLCs,” she says. “Most business owners don’t have a formal payroll or have themselves on a formal payroll, so it still leaves out a chunk of people that it was intending to help.”
Businesses that qualify and want to cash in on ERC changes retroactively will need to amend prior years' tax returns to lower accompanying payroll expenses.
“You need to reduce the expense in the year in which you’re claiming [the credit], not the year you’re receiving it,” says Ryan Losi, a certified public accountant and the executive vice president of Piascik, an accounting firm headquartered near Richmond, Virginia. “The IRS says some [ERC] claims will take a year to process.”
That means business owners need to amend personal and business returns from the prior year without actually having cash in hand — and in their books — from the credit.
A previous version of this article misspelled Armine Alajian's name. It has been corrected.