FAQs on Tax Treatment for COVID Relief Programs

The COVID-19 pandemic created a vast network of small business relief programs in the form of loans, grants, tax credits and direct payments. From the Paycheck Protection Program (PPP) to the Employee Retention Credit (ERC), small businesses were infused with billions of dollars in government assistance to keep the economy running and businesses afloat.

Now that these programs are expiring, it is time to report all these funds on taxpayers’ 2021 business tax returns. This article will serve as a cheat sheet to taxpayers and practitioners to properly report COVID-19 relief funds on their 2021 tax returns.

Q1: Is the receipt of a PPP loan taxable?

A1: No. Just like any loan, the receipt of a PPP loan is not taxable because there is a repayment obligation when it is received.

Q2: Is PPP loan forgiveness taxable?

A2: No. Even though the discharge of indebtedness generally is a taxable event, the CARES Act specifically states that the amount of PPP loan forgiveness that would have been taxable is excluded from gross income.

Q3: Are expenses related to PPP loan forgiveness deductible?

A3: Yes. Despite prior guidance from the IRS (now withdrawn), legislation enacted on December 27, 2020 provides that expenses that give rise to PPP loan forgiveness are tax deductible. For more information, see our article on this change in law.

Q4: How is PPP loan forgiveness reported on books?

A4: The PPP loan when received is recorded as a loan on the balance sheet and the portion that is forgiven is written off to the income statement as tax-exempt income. The PPP loan forgiveness amount is not taxable but it will increase book income on the income statement.

Q5: How is PPP loan forgiveness reported on S corporation tax returns – AAA or OAA?

A5: The draft instructions to IRS Form 1120-S (released December 22, 2021) provide that the PPP tax-free income and the expenses giving rise to forgiveness in the Other Adjustments Account (OAA), and not in the Accumulated Adjustment Account (AAA). This can save taxpayers a lot of money, as we explained in our article on this topic.

Q6: How do I report PPP forgiveness on my Form 1040?

A6: If youreport your business income and deductions on schedule C of your individual tax return (Form 1040), then you report your PPP-related deductions as usual and there is no loan forgiveness to report because it is tax-free.

Q7: When do I report the tax-exempt income relating to PPP loan forgiveness?

A7: The IRS allows taxpayers to recognize PPP loan forgiveness either (i) as the eligible expenses are paid or incurred, (ii) when an application for PPP Loan forgiveness is filed, or (iii) when PPP Loan forgiveness is granted. See our article on this topic.

Q8: Will PPP loan forgiveness be taxable on my state income tax return?

A8: Most states conform to the federal income tax treatment of PPP loan forgiveness but some states either disallow the expenses or treat the loan forgiveness as taxable. Check with your specific state to see its treatment.

Q1: Are EIDLs taxable?

A1: No. Just like any loan, the receipt of an EIDL is not taxable because there is a repayment obligation when it is received. Unlike the PPP, EIDLs are non-forgivable and they need to be repaid with interest. Expense disallowance does not apply, and expenses paid with EIDL proceeds are fully deductible, assuming they are otherwise valid business expenses.

Q2: Are EIDL Advances taxable?

A2: No. Government grants generally are taxable, but legislation enacted on December 27, 2020 specifically excludes EIDL advances from taxable income. This exclusion covers both the first and second EIDL targeted advance programs.

Q1: Is the ERC taxable?

A1: Effectively, yes. While the amount of the ERC received is not includible in gross income, the expenses giving rise to the ERC are not deductible for tax purposes. For example, if a taxpayer receives a $1 million ERC, then it must reduce its deductible expenses (i.e., salary or health plan expenses) by $1 million. By reducing the amount of tax-deductible expenses, this effectively taxes the amount of the ERC.

Q2: Are expenses used to claim the ERC deductible?

A2: No. The salary or health plan expenses giving rise to the ERC are reduced by an amount equal to the amount of the ERC received. For example, if $10,000 in wages were used to claim a $5,000 ERC, then deductible wages are reduced by $5,000 and not by the full $10,000 used to claim the ERC.

Q3: Are expenses used to claim the ERC deductible on my state income tax return?

A3: The ERC is a federal tax credit, and states treat federal tax credits differently. Some states allow taxpayers to deduct eligible expenses in full, and others follow the federal tax treatment and disallow the expenses up to the amount of the ERC received. Typically, a state’s tax treatment of the ERC is similar to its treatment of R&D tax credits.

Q1: Are Paid Sick Leave and Paid Family Leave (FFCRA) credits taxable?

A1: The tax treatment of these credits follows the treatment of the ERC; the amount of the FFCRA tax credits is not includible in gross income but the expenses giving rise to the credits are not tax deductible. In short, receiving a FFCRA tax credit is like a government reimbursement of wages that neither increases nor decreases taxable income.

Q2: Are expenses used to claim FFCRA credits deductible?

A2: The expenses giving rise to FFCRA tax credits are reduced by an amount equal to the amount of then FFCRA tax credits received. For example, if $10,000 in wages were used to claim a $10,000 FFCRA tax credit, then deductible wages are reduced by $10,000.

Q3: Are expenses used to claim FFCRA credits deductible on my state income tax return?

A3: FFCRA credits are federal tax credits, and states treats federal tax credits differently. Some states will allow taxpayers to deduct eligible expenses in full, and others follow the federal treatment and disallow the expenses up to the amount of the credits received.

Q1: Are SVOG funds taxable?

A1: No. Legislation enacted on March 11, 2021 provides that SVOG funds “shall not be included in the gross income of the person that receives such grant.”

Q2: Are expenses paid with SVOG funds deductible?

A2: Yes. Eligible expenses paid using SVOG funds are fully tax deductible.

Q3: How are SVOG funds reported on my books?

A3: SVOG funds are recorded as tax-free grant income on the income statement. The amount received is not taxable but will increase book income on the income statement.

Q4: How are SVOG funds reported on S corporation tax returns – AAA or OAA?

A4: Both the tax-exempt income andthe related expenses should be reported in OAA and not in AAA.

Q5: How do I report SVOG funds on my Form 1040?

A5: If you report your business income and deductions on schedule C of your individual tax return (Form 1040), then you continue to use Schedule C as usual, do not include the SVOG funds in income, and you can deduct the expenses paid with SVOG funds.

Q6: Will SVOG funds be taxable on my state income tax return?

A6: Most states conform to the federal income treatment of SVOG funds, but some states may either include the funds in income or disallow the related expenses. Check with your specific state to see its treatment.

Q1: Are RRF funds taxable?

A1: No. Legislation enacted on March 11, 2021 provides that RRF funds are not includible in taxable income.

Q2: Are expenses paid with RRF funds deductible?

A2: Yes. Eligible expenses paid using RRF funds are fully tax deductible.

Q3: How are RRF funds reported on my books?

A3: RRF funds are recorded as tax-free grant income on the income statement. The amount received is not taxable but will increase book income on the income statement.

Q4: How are RRF funds reported on S corporation tax returns – AAA or OAA?

A4: Both the tax-exempt income andthe related expenses should be reported in OAA and not in AAA.

Q5: How do I report RRF funds on my Form 1040?

A5: If you report your business on schedule C of your individual tax return (Form 1040), then you continue to use Schedule C as usual, do not include the RRF funds in income, and you can deduct the expenses paid with RRF funds.

Q6: Will RRF funds be taxable on my state income tax return?

A6: Most states conform to the federal income tax treatment of RRF funds, but some states may either include the funds in income or disallow the related expenses. Check with your specific state to see its treatment.