What You Need to Know about the Paycheck Protection Program (“PPP”) and the Tax Deductibility of Expenses Related to Loan ForgivenessAnchin AlertMay 27, 2020
The PPP Loan Program offers much needed relief to qualified businesses struggling with the challenges of the COVID-19 crisis. Yet the ongoing changes to the rules for borrowing and loan forgiveness have made navigating the program and claiming benefits challenging as well. Let’s review a key topic - the taxation of both loan forgiveness and the expenses paid with PPP Loan proceeds.
Tax Deductibility of Expenses Paid Using PPP Funds
There have been many questions regarding the tax deductibility of the expenses paid using PPP funds qualifying for forgiveness. On April 30th, the IRS issued Notice 2020-32 providing guidance related to this issue. In the notice, the IRS has determined that to the extent of loan forgiveness, the related expenses will not be tax deductible. The IRS is attributing the qualifying expenses to the forgiven PPP loan which is excluded from gross income and therefore determined to treat the expenses as non-deductible for tax purposes. Their reasoning behind this is to prevent the double dipping of taxpayer benefits related to the combination of tax exempt income (PPP loan forgiveness) and deductible expenses which would further erode tax revenue. It is important to note that even though the expenses may not be deductible, the PPP is still a positive from a cash flow perspective and puts cash into the hands of many businesses that are suffering and would otherwise not have had these funds to pay payroll and other eligible expenses.
An Example Assuming that a $1M PPP Loan was Received
Assume a business receives a $1M PPP Loan and that $900,000 of expenses qualify for loan forgiveness. The remaining $100,000 is not eligible for forgiveness, but still qualifies as a PPP loan.
The $900,000 proceeds that were used on qualifying expenses, during the 8-week “Covered Period” or the new “Alternative Payroll Covered Period” after the funds were received, will be treated as tax exempt loan forgiveness. At present, the $900,000 of qualifying expenses paid from those funds will not be deductible for income tax purposes. This creates a zero tax impact under the Notice and therefore, in a roundabout way, makes the loan forgiveness taxable. In other words, you get the same net result if the loan forgiveness was taxable and the qualified expenses were deductible.
With regards to the remaining $100,000, the taxpayer will treat that amount as a loan subject to repayment at a 1% interest rate payable within 2 years. The expenditures relating to the $100,000 paid using the proceeds will be deductible for income tax purposes.
Please note that the Small Business Administration (SBA) has provided guidance in its loan forgiveness application that allows a taxpayer to include both “paid” and “incurred” eligible payroll expenses for forgiveness. Payroll costs are considered “incurred” on the date the employee’s pay is earned. This means if a taxpayer’s pay date is after the 8-week period, a taxpayer may still include the incurred payroll and qualify for forgiveness. However, to be eligible for forgiveness, the incurred payroll must be paid on or before the next regular payroll date.
Congressional Intent and Reaction to IRS Notice 2020-32
The CARES Act indicates that the forgiveness is to be treated by the banks as cancelled indebtedness by a lender authorized under section 7(a) of the Small Business Act. Cancellation of Debt Income (“CODI”) is normally taxable unless the law allows you to exclude it from gross income. Section 1106(i) of the CARES Act specifically excludes the PPP loan forgiveness from gross income. Since without this last section, you would get the same result if the forgiveness created taxable gross income and taxable deductions as non-taxable income and non-deductible expense, it appeared Congress intended to allow for exemption of the forgiveness income while allowing the deduction of the related expenses, so allowing for – the double dipping.
The day after Treasury issued the Notice, both the Senate and House chairs of the Ways & Means Committees along with the tax-writers committees stated that the IRS overstepped its authority, indicating the Notice went against the Congressional intent of the forgiveness statute. They have advised that they plan to reverse this ruling in the next phase of legislation, “CARES Act 4”.
The House has currently included a legislative fix for the deductibility issue in the recently proposed HEROES Act legislation which is currently stalled in the Senate. Should these provisions be enacted into law, businesses receiving loan forgiveness under the PPP Loan Program will receive additional relief in the form of tax savings to help them through the crisis.
Stay tuned for more information to follow.
Please reach out to your Anchin Relationship Partner or a member of our Services Group so that we can personally address your questions and concerns. You can also contact our Anchin COVID-19 Resource Team at COVID19@anchin.com.
Disclaimer: Please note this is based on the information that is currently available and is subject to change.