Are COVID Grants Taxable Income to a Business?

The COVID-19 pandemic prompted the federal government to introduce various financial relief programs for businesses, including grants and forgivable loans. A common question for business owners is whether these funds are considered taxable income. While general grants are typically taxable, specific legislation often excluded them from gross income for federal tax purposes. However, the tax implications can vary depending on the specific program and also differ at the state and local levels.

Federal Tax Treatment of Key COVID Relief Funds

The federal tax treatment of many COVID-19 relief funds was largely clarified by the Consolidated Appropriations Act, 2021 (CAA), signed into law in December 2020. This legislation stipulated that certain funds received by businesses would not be included in gross income, and expenses paid with these funds would remain deductible.

The Paycheck Protection Program (PPP) provided loans to businesses, which could be forgiven if certain conditions were met, primarily related to payroll and other eligible expenses. The CAA explicitly states that the forgiven portion of PPP loans is not included in gross income for federal tax purposes. Furthermore, businesses are allowed to deduct otherwise allowable expenses paid with these forgiven PPP funds. For pass-through entities like partnerships and S corporations, the excluded income from PPP loan forgiveness is treated as tax-exempt income, increasing the owner’s basis in their entity.

Economic Injury Disaster Loan (EIDL) Advances, also known as EIDL grants, were direct funds provided to businesses that did not need to be repaid. These advances are excluded from gross income for federal tax purposes. Additionally, expenses paid with EIDL advances remain fully deductible, assuming they are otherwise valid business expenses.

The Shutter Venue Operators Grant (SVOG) program offered emergency assistance to eligible live venues, theaters, museums, and similar entities. Under the CAA, SVOG funds are not included in gross income for federal income tax purposes. Expenses paid with SVOG proceeds are also fully tax deductible.

Similarly, the Restaurant Revitalization Fund (RRF), established by the American Rescue Plan Act of 2021, provided grants to eligible restaurants and other food and beverage businesses. Funds received from the RRF are not treated as taxable income for federal purposes. Moreover, expenditures paid with RRF grant funds remain deductible on federal income tax returns.

State and Local Tax Treatment Considerations

While federal legislation clarified the non-taxability and deductibility of certain COVID-19 relief funds, state and local tax treatment can differ significantly. States are not uniformly required to conform to federal tax law regarding the exclusion of these funds from income or the deductibility of related expenses.

States typically adopt federal tax law in one of three ways: rolling conformity, static conformity, or selective conformity. Rolling conformity states generally adopt changes to the Internal Revenue Code (IRC) automatically, meaning they might align with federal treatment unless they specifically decouple. Static conformity states, however, conform to the IRC as of a specific date, requiring legislative action to adopt newer federal changes, including those related to COVID-19 relief. Selective conformity means a state chooses to adopt only certain federal provisions.

Even in states with rolling conformity, legislative or administrative action may be taken to “decouple” from specific federal provisions, meaning they will not follow the federal tax treatment for certain COVID-19 grants. For example, some states may still consider PPP loan forgiveness as taxable income, or disallow the deduction of expenses paid with these funds, despite federal non-taxability. Businesses need to consult their state’s department of revenue or a qualified state tax professional to understand the specific tax implications in their jurisdiction, as rules vary widely and can change.

Reporting COVID Relief Funds on Tax Returns

Properly reporting COVID-19 relief funds on tax returns requires careful attention, even for those funds deemed non-taxable federally. While the non-taxable nature of programs like PPP forgiveness, EIDL advances, SVOG, and RRF means they are generally not included in gross income on federal tax forms, businesses still need to maintain meticulous records. This record-keeping is crucial for demonstrating compliance with program requirements and for substantiating the use of funds for eligible expenses.

For federal tax purposes, non-taxable grants or forgiven loans typically do not appear as income on the primary lines of business tax forms, such as Schedule C for sole proprietors or partnership and corporate returns. However, the amounts received might need to be disclosed on supporting statements, footnotes, or as adjustments. For pass-through entities like partnerships and S corporations, the tax-exempt income from these grants can increase the partners’ or shareholders’ basis in their entity, which is an important consideration for tax calculations.

In scenarios where a grant might be taxable, either federally or at the state level, it would typically be reported as ordinary business income. Businesses should carefully review any Forms 1099-G or other informational returns received, as these forms indicate payments from government agencies and may suggest taxability. Consulting with a tax preparer is advisable to ensure accurate reporting and to navigate any complexities, particularly when state tax rules diverge from federal guidelines.