Based on recent IRS guidance, any Payroll Protection Program (PPP) loan forgiveness may have a tax impact on your freelance business. How much this will impact your tax obligations depends on the extent to which you are applying for forgiveness based on overhead and other third party costs, which will not be deductible on your 2020 tax return. If you are planning to apply for PPP loan forgiveness, or you already have and are waiting for a final determination, here’s what you need to know:
1. If you are applying for PPP loan forgiveness based on payroll, rent, or other eligible expenses, they will not be tax deductible (preventing a double dip by taxpayers), and by inference this may increase your taxes. If for example you are applying for a PPP loan forgiveness amount of $10,000 of payroll and $5,000 of rent expenses, that $15,000 cannot be deducted on your 2020 tax return—which increases your tax liability.
Other expenses which may also receive the same tax treatment if you calculate them into your PPP loan forgiveness amount include utility costs such as electricity, gas, water, transportation, telephone and internet. and mortgage interest. This is applicable only to contracts that were in place before Feb. 15, 2020.
While the formal guidance for most states is still pending, it is likely that they will conform with the Internal Revenue Service code, so you should plan on having a taxable event in this situation at the state level as well.
2. If your PPP forgiveness is based on sole-proprietor or active LLC members profits, you should not consider them to be taxable on your 2020 return. This is because the profits are viewed by the IRS as equivalent to a freelance business owner’s salary, on which they pay income and self-employment taxes. As such this will not have a tax impact for PPP loan forgiveness and are not deductible. Keep in mind that salaries over $100,000 are excluded from forgiveness eligibility.
As an example, if you apply for PPP loan forgiveness based on $10,000 profit on Schedule C of your tax return, or the equivalent for partnership returns, this amount will not have a taxable impact on your tax situation because it was not listed as a deductible expense for tax purposes.
The IRS provides safe harbor for unforgiven PPP loans. The IRS also recently announced an unforgiven PPP loan safe harbor regulation for the 2020 tax year, allowing freelancers who forego requesting loan forgiveness to claim a deduction for the otherwise deductible eligible payments on an original income tax return or information return. If you believe you are eligible to receive forgiveness on your PPP loan and you plan to apply for forgiveness next year, it is critical that you carefully consider which expenses you are eligible to deduct on your on your 2020 tax return otherwise you could end up with an unplanned tax liability.
Jonathan Medows is a New York City-based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country. He provides tax, accounting and business articles for freelancers on his website, http://www.cpaforfreelancers.com, which also features a blog and a comprehensive freelance tax guide. Please note, due to the high volume of inquiries in regard to COVID-19, Jonathan is not able to respond to individual requests for information at this time.