Tax Treatment of Federal COVID Relief
Since the beginning of Governor Polis’ Stay-at-Home order in March, many of you have applied for and received federal small business relief. This could have come in the form of a Payroll Protection Program (PPP) loan, an Employee Retention Tax Credit (ERTC), the Main Street Lending Program, or one of the other programs under the Families First Coronavirus Relief Act (FFRCA) or subsequent CARES Act.
While our current focus is returning the Colorado economy to a state where we can resume unencumbered in-person auto sales, it is worth a look at the future implications of receiving federal relief.
As a disclaimer, the purpose of this article is to review federal relief programs. Any relief acquired through the state of Colorado, or your county or municipality (such as the Aurora Economic Relief Act) will not fall within this framework.
The biggest question on dealers’ minds right now is the taxability of relief programs. If you remember back to 2008 when George W. Bush issued stimulus checks to each taxpayer in order to revive the economy, those checks became taxable income in the following year. Incidentally, this year’s stimulus checks to individuals will NOT be taxed in the same manner.
Typically, when a business has a loan, and any part of that loan is forgiven, the forgiven portion of the loan is considered taxable income for the business in the year it is forgiven. Therefore, if a business were to take a million-dollar loan and $250,000 were forgiven, there could potentially be a $50,000 tax liability [through a 20% C-corporation tax rate].
Payroll Protection Program Loans
The good news regarding PPP loan forgiveness is that when Congress passed the CARES Act, the law expressly excluded from income any loan forgiveness from this program. So, a dealer will not have a federal tax liability based on the portion of their PPP loan that covers payroll (i.e. “is forgiven”).
But, how will Colorado respond to the forgiven loan? Through conversations with the Colorado Department of Revenue, we are told two things. First, the starting point for applying a state income tax is typically federal taxable income. Therefore, if this loan forgiveness is excluded federally, Colorado excludes at the state level. That is, unless it’s added back under Colorado Revised Statute 39-22-105 or 39-22-304.
In our interpretation, these sections do not ‘re-add’ PPP loan forgiveness to state tax liability. The caveat to this assumption is that the legislature can alter these statutes by legislative action. We do not believe there is a movement to do so at this time but are cognizant of a ground-moving budgetary shortfall in this legislative term and the next. CADA will continue to monitor relevant activity out of the Colorado Capitol.
Employee Retention Tax Credit
Finally, the Employee Retention Tax Credit is a refundable tax credit that operates as an alternative to PPP loans – or relief to companies who don’t qualify for SBA programs. The credit works by allowing a dealer to recover 50% of the wages paid to an employee (up to $5000), which can then be deducted against the employer portion of social security taxes, under 26 USC 3111(a). A dealer, however, cannot take the tax credit if they have already received a PPP loan. The programs compensate the same things.
Since this program operates as a refundable tax credit and not an “advance”, it will not be taxable as income at the federal or state levels in future tax years. It merely impacts the dealer’s tax liability for tax year 2020. The impact should be limited to this year.
Equal tax treatment of federal relief is helpful because many dealers will have to choose between the tax credit and the PPP loan. Knowing that the two will likely be treated the same when it comes to future taxation should level the playing field for a small business owner who has to choose. Alternatively, if you have already made deductions pursuant to the ERTC prior to submitting your PPP Loan Application, you will not have put yourself at a disadvantage from a tax perspective.
There are separate questions raised as to how much or which parts of PPP loans are eligible for forgiveness. For those issues, we refer you to recently updated NADA guidance here. This is based off ongoing conversations with both the legislature and the Small Business Administration. Their lobbying efforts to move the status quo in the dealers’ favor are ongoing.
If you have any questions on these programs or their tax liabilities, please contact Matthew Groves at firstname.lastname@example.org or 303-282-1449.