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Updated: Jul 24, 2020
The COVID-19 pandemic has no doubt taken business owners on a roller coaster ride. Throughout the ups and downs, one constant was the need for cash flow after the pandemic-infused lockdowns caused millions of business owners to close their doors through no fault of their own. The government’s rescue package, known as the Paycheck Protection Program, was wrapped up in the CARES Act, delivering hundreds of millions of dollars of relief to the small business community.
Chief among the features of PPP is loan forgiveness. This aspect drew in cash-strapped business owners by the millions across hundreds of billions of dollars in financing. Now that 2020 is halfway over, it won’t be long before Uncle Sam comes knocking again. Meanwhile, the original CARES Act’s language didn’t make it clear to many whether or not the PPP loan forgiveness amounts would be tax-deductible.
The Internal Revenue Service (IRS) must have noticed and issued a statement on what PPP tax forgiveness means for you. The short answer is that PPP and business taxes are not cut and dry and are still being debated. We’ve provided a glimpse into what you can expect below.
In a nutshell, PPP falls under the government’s CARES Act. This program was launched in April 2020, and the SBA has since approved close to 5 billion forgivable loans. PPP loan forgiveness applies as long as the funds are used toward the following:
The SBA says that 60% or more of the PPP loan forgiveness amount must be directed toward payroll costs. (Previously, the threshold was 75%, but it got lowered in the second wave of loans.) The business owner could also qualify for partial forgiveness if they don’t meet the required threshold, which is better than nothing.
The IRS notice basically quashes the possibility that the borrower of the PPP loan will benefit twice from the forgiveness feature. There is quite a bit of tax jargon that led them to this conclusion, so let’s attempt to break it down a bit.
According to the IRS, the loan amount that qualifies for forgiveness under the CARES Act is tax-exempt under certain sections of the tax code. Now according to a subsection of that tax code, the borrower can’t deduct the amount of the PPP loan that’s allocated to income if it’s already exempt from taxes. Based on the point mentioned above, it is. The IRS spells out this rule regarding PPP and business taxes in the notice when it says,
“As a result, any PPP loan amounts used for Covered Expenses will not be deductible to the extent such loan amounts are forgiven. The tax consequences to a loan recipient will be the same as if the PPP loan amounts received were included in gross income and subject to tax.”
If you’re thrown for a loop by this decision, you’re not alone. When the program was approved, Congress kept the PPP loan amounts separate from gross income. After all, the CARES Act states that the PPP loan forgiveness amount is excluded from gross income “for purposes of the Internal Revenue Code of 1986.”
The hammer has fallen, however, and forgiven amounts don’t qualify for gross income. As a result, taxpayers can’t “double-dip” and claim PPP tax forgiveness on free money that was delivered through the program to offer financial relief.
But some U.S. lawmakers are crying foul, saying that this decision is not in the spirit in which the emergency relief funds were intended. As a result, the situation regarding PPP tax forgiveness remains somewhat fluid and could change before tax day. While this introduces some ambiguity to the case, it could work in favor of the small business community. It has been through enough already in 2020.
So what does this situation around PPP loan forgiveness all mean for you and your taxes? In short, it depends.
Let’s explore some scenarios you could find yourself in as it relates to PPP loan forgiveness and your business taxes, with a nod to JD Supra for the suggestions.
In this example, let’s say you have a business loan and will be allocating $1 million to payroll taxes with or without a PPP loan. Now let’s take it a step further and say you are approved for a million-dollar PPP loan. You then direct the funds toward payroll expenses under the qualifying criteria for covered expenses. Because of the relationship between PPP and business taxes, your entire loan is eligible for forgiveness.
Before the IRS’ ruling on PPP tax forgiveness, you score a net benefit of $1 million. That’s because you don’t have any loan funds left to be taxed. But in a post-IRS notice world, you must tack on another $1 million in taxable income. As a result, you must fork over some $210,000 to Uncle Sam. You still come out on top with a net benefit of $790,000.
For example, No. 2, let’s apply the same scenario with the exception that you don’t intend on paying the payroll expenses without the PPP funds. In this case, there’s no real perk to receiving this particular loan. Without it, you’d have to implement layoffs or some reduced work hours to escape payroll expenses. This doesn’t affect your taxes one way or the other. The same holds true if you do get the PPP loan.
Remember, as it pertains to PPP loan forgiveness, the covered amount can’t be deducted on your taxes. Prior to the IRS’ decision, you would have been entitled to a net benefit for the deduction amount. In this case, that would be $1 million. But in light of the IRS decision, you may want to consider whether the time and effort to get approved for the loan is worth keeping employees on the payroll.
Let’s carry over the breakeven scenario but change it so that you use more than 25% of the loan for expenses not covered under the PPP loan forgiveness feature. Using more than 25% of the loan for “non-forgiven” expenses means you are stuck with the tab for the non-covered amount. Also, considering the covered amount can’t be deducted on your income tax, there’s no real tax impact.
But you’re still on the hook for the non-covered amount that you didn’t use for payroll. As a result, the benefit of PPP tax forgiveness would be of no real benefit to you. Without the IRS decision, you’d at least been able to benefit from a deduction on the covered amount. This would remove some of the sting from the amount of the PPP loan you were responsible for. But you can’t take the genie out of the bottle – unless Uncle Sam changes his mind.
Jessica Holcomb is the Content Marketing Manager at Funding Circle, specializing in small business marketing and social media. She has a degree from the Fashion Institute of Design and Merchandising. Prior to Funding Circle, Jessica was a Marketing Manager at a successful social games company and a freelancer for many small businesses in the Bay Area. Her work can be seen in top retail, gaming, and financial small business resource sites.