By now as most of you know, the Paycheck Protection Program (PPP) as established by the CARES Act provides recipients with loan proceeds to be used to pay certain business costs including payroll, interest, rent and utilities. To the extent that such proceeds are used to pay these expenses during an 8-week “covered period”, the loan may be forgiven partially or in its entirety based on other requirements. The balance of the loan proceeds that are not forgiven are rolled into a 1% loan paid back over two years. We knew on day 1 of PPP that the amount of loan that is forgiven is not considered “income” for Federal tax purposes. It almost seemed too good to be true: a cheap loan from the SBA combined with a forgiveness component with no Federal tax consequences? Sounds like a great deal, right?
Not quite. On Thursday, the IRS issued Notice 2020-32 providing clarity on the tax effect of PPP funds. The Notice acknowledges that the forgiveness component of PPP is not to be included in “taxable income.” However, the Notice also states that those expenses that are paid with forgiven PPP funds are not deductible for Federal income tax purposes. Even though the inbound money that gets forgiven is not taxable income, the outbound expenses funded with PPP “forgiven proceeds” are not deductible. For example, let’s assume a company receives a $100,000 PPP loan and uses $80,000 in the 8-week covered period for payroll and other qualifying expenses resulting in forgiveness of $80,000. Although the forgiveness of the $80,000 is not taxable income, this Notice states that the payroll and other expenses of $80,000 will not be deductible.
First question that many people are asking is “why”? Per the Notice, the IRS is concerned with the potential for a double tax benefit. In other words, if tax-free money comes in, then by providing a deduction for that money on the way out gives rise to a double tax benefit. This so-called “tax benefit rule” is a fundamental component of tax law and the IRS has extended this concept to the PPP. Their theory is that tax-free income should not and will not give rise to tax-deductible expenses.
So what does this mean? Very simply, this is a critical issue that you cannot ignore. If your business is fortunate enough to be generating income, then this will result in even more taxable income because expenses paid with these forgivable loan proceeds will not be a deduction. Perhaps you’re not making money and generating a loss. You’ll need to revisit this for tax purposes as many of those expenses that you thought were generating a loss will likely need to be added back into income for tax purposes. Furthermore, you may have taxable income with no cash to fund your tax payments. Everyone should consider the effect of the PPP money immediately. Contact your Baker Holtz advisor to begin the discussion – especially during the forgiveness certification process. You may need to consider a mid-year tax projection to quantify your tax liability and to avoid a “surprise” on your 2020 return. In a world full of surprises, let’s work together to prevent an unforeseen 2020 tax bill!
For more information on PPP, the CARES Act, or a mid-year tax projection please contact any member of Baker Holtz team at (616) 458-1835.