Are Business Grants Taxable Income?
"Are grants taxable?" is a common question for small business owners who receive financial assistance. Business grants are non-repayable funds given by governments, nonprofits, or private entities to support business activities.
Generally, the Internal Revenue Service (IRS) considers business grants taxable income as they're considered an accession to wealth that increases your assets under IRC Section 61. A tax professional will help you understand your tax obligations and prepare to report a business grant on your tax return.
How to Know If a Business Grant Is Taxable Income
Most business grants are considered taxable income. However, a grant’s tax status will depend on the source and how the funds are used. Generally, only business grants that are specifically exempt under IRS rules or those tied to non-taxable purposes (such as some disaster relief programs) are considered non-taxable income.
Key Factors that Determine Grant Taxability
Business owners should assume business grants they receive are subject to income tax. However, the following factors will indicate whether or not a grant will trigger income tax obligations:
Source of the grant: Grants from federal, state, or local governments are likely taxable, unless explicitly stated otherwise.
Purpose of the grant: Grants awarded to cover general business expenses like payroll, rent, or supplies are typically taxable.
Grant conditions: Grants often come with specific instructions for their use. If a grant agreement stipulates that funds must be used in a way that leads to direct financial benefit (for example, covering marketing), they're almost certainly taxable.
IRS guidelines: The IRS will generally include business grants in gross income unless there's a specific exception. Refer to the IRS website and consult a professional in small business tax planning for confirmation and to ensure compliance.
Situations in Which Business Grants Aren't Taxable
Businesses should assume grants are taxable income and take steps to meet their tax obligations. However, some grants are tax-free:
Disaster Relief Grants
Grants received after a federally declared disaster (for example, wildfires or hurricanes) may qualify as non-taxable under IRS disaster relief provisions. This is because these grants are typically intended to restore operations or recover losses, not directly generate financial benefits.
Specific Nonprofit Grants
The income nonprofits receive via grants to carry out activities directly related to their tax-exempt mission isn't typically taxable. However, nonprofits will generally pay tax on business income unrelated to their specific mission.
Specific Relief Grants
Some specific historic grants, for example, the Shuttered Venue Operators Grant during the COVID-19 pandemic, were exempt from federal income tax. Future grants given in exceptional circumstances will likely require specific legislation to guarantee their tax-exempt status.
Be aware that state tax rules may differ. While most states follow federal tax treatment of grants, some may exempt specific programs. Always verify with your state’s department of revenue.
Taxation of Cash vs Non-Cash Business Grants
Grants often come in cash form. However, non-cash grants, like free equipment, property, or professional services provided to support your operations, are also common. The IRS treats in-kind grants the same as cash grants for tax purposes. Their fair market value (FMV) must be included in gross income.
Remember, cash grants will almost always be considered taxable income. Grant recipients must report cash received as part of a grant on their business tax return, as they would with any other revenue.
IRS Treatment of Non-Cash Grants
Non-cash grants don't involve an exchange of cash, but the items or services donated still have an FMV that the IRS considers taxable.
For example, a small marketing agency in Jacksonville, Florida, receives free legal services to help draft client contracts and update its business structure. These services would usually cost $3,000. In this case, the IRS would consider the FMV of the legal services received ($3,000) as taxable income. The marketing agency must report the figure as part of its gross income as it directly benefited from a service with a measurable economic value.
When Are Non-Cash Grants Non-Taxable?
Non-cash grants are non-taxable when they're classified as federally declared disaster relief. Non-taxable grants are awarded in extreme circumstances to restore essential operations, not to generate profits.
Let's imagine a small restaurant that receives free refrigeration equipment to replace items destroyed in a hurricane. The grant was a non-cash disaster relief grant from a federal recovery agency, awarded to help restore basic operations. This grant would be considered non-taxable and therefore excluded from the restaurant's gross income on its tax return.
Best Practices When Handling Taxable Business Grants
The following best practices will help your business handle your grant funds effectively, avoid administrative headaches, and stay compliant with IRS guidelines:
1. Confirm Whether the Grant Is Taxable
Assume that every business grant is taxable unless stated otherwise. You can confirm this by checking the grant's documentation or consulting an expert in tax planning. A professional will also be able to advise on the amount to set aside to meet your tax obligations when you file.
2. Keep Meticulous Records
Taxable grants should be recorded as "Other Income" on your books. You may need to record the funds as deferred income and recognize them when expenses are incurred if the grant was awarded for a specific use.
Keep all business grant-related documentation for at least seven years. This includes:
The grant agreement and any correspondence
Proof of funds received
Evidence of spending
Tax filings
Amendments related to the grant
3. Track How You Use the Funds
Tracking how you use grant funds is essential to protect yourself in the case of an audit or if the grantor requests a use-of-funds report. It's wise to:
Create a separate project code or tracking category if you're using accounting software to avoid confusion or mistakes.
Keep all receipts, invoices, payroll reports, contracts, and any other paperwork related to the grant.
4. Understand Tax Deduction Implications
Taking advantage of business deductions is one of the best ways to reduce taxable income in your business. Your grant will have different impacts on deductions depending on the nature of the transaction. The key is to avoid "double dipping," which could cause compliance issues:
In most cases, expenses paid with grant funds remain deductible unless the grant terms or IRS rules specifically prohibit it. Always review the grant agreement for restrictions.
However, if the grant reimburses you for specific expenses that were already deducted, seek professional advice to avoid duplication and non-compliance.
How to Report Business Grant Income to the IRS
How and where you report business grant income will depend on your business structure and the nature of the grant. Always consult an expert if unsure, as taxation rules vary.
Once you've confirmed your grant is taxable, report it as part of your gross income:
Sole proprietors and single-member LLCs: Report the grant funds on Schedule C (Form 1040) as part of your business income.
Partnerships: Include grant funds on Form 1065. Each partner's share must be distributed on Schedule K-1.
S corps: Report grant income on Form 1120-S as part of other income.
C corps: Report grant income on Form 1120 as part of other income.
Top Tip: Some grant providers issue 1099 Forms to show the total amount your business received in the grant. These forms also go to the IRS. Ensure you report the same amount in your tax return to avoid discrepancies.
How to Find and Apply for a Business Grant
Business grants offer an invaluable injection of funds for your growing business without taking on debt. Grants come from many different sources, ranging from government agencies like the U.S. Small Business Administration (SBA) to nonprofit organizations.
Competition for federal grants is fierce, as applicants apply from across the country. It may be easier to secure a grant from a local source, where the impact of the grant is more easily appreciated. There is also a range of grants for businesses owned by minorities or women. Check for grants that align with your business for the best chance of receiving funds.
Try the following places to find relevant grants:
Check the official database for federal grants. Filter by eligibility, category, or agency to narrow down your options.
Check local sources like your state's economic development office, Small Business Development Centers, or local chambers of commerce.
Stay informed about business grant programs offered by large corporations.
Explore foundation directories like Candid for nonprofit and private grants.
Take your time to prepare a compelling application. This should include a clear business plan detailing how you'll use the funds, any supporting documents, and a memorable grant proposal that explains your business's mission and the measurable impact the funds will have.
Tax Treatment of Business Grants vs Personal Grants
Business grants and personal grants aren't always subject to the same tax treatment. Many personal grants, like Pell grants or scholarships from an educational institution, aren't usually taxable. However, some other forms of financial assistance are taxable; consult an expert when in doubt.
Navigating Taxes on Your Business Grant Successfully
Understanding whether your business grant is taxable helps you plan ahead, stay compliant, and avoid unexpected tax liabilities. Most grants are taxable, with specific exceptions.
Always review the grant terms, track how you use the funds, and seek professional tax advice when in doubt. With careful planning and accurate reporting, you will make the most of your grant while staying on the right side of the IRS.
