Updated: Jan 10, 2021
Note: Since this post was originally published Congress has passed a second stimulus package some of which affects the details of this blog post. IRS has also issued another Notice in response. Please refer to our latest post for the most up to date information.
Recently the IRS issued Notice 2020-32 to provide guidance related to the deductibility of expenses paid with Paycheck Protection Program (PPP) funds covered under the forgiveness provisions of the PPP Loan program.
The gist of the notice is that, while the loan itself is NOT taxable, the expenses you paid with the funds which will be used to certify your forgiveness: payroll, rent/mortgage interest, and utilities, will NOT be deductible for federal tax purposes.
This is not a surprise really. One need to only consider the government's treatment of other tax exempt income. If we apply those same rules and traditional tax principles to the PPP loan consistently, you shouldn't be able to get free money, not pay tax on the debt forgiveness, and still deduct the related expenses. That would result in a double dip and the IRS never allows that to happen.
That being said, there is still an argument being made by Congress that they disagree with the IRS' position and that the intent of the CARES Act and related PPP program, was to allow the deduction of these expenses. Congress has expressed their plans to correct this through future legislation, but until that is done, you should be prepared to have those related expenses disallowed and in effect have an increase in income which will potentially result in additional taxes owed.
It is important to understand that the amounts paid to the business owner and their employees as "wages" will be taxable to the employee and the business owners no differently then they would have been absent the PPP funding. However, under traditional circumstances those amounts would have been a ordinary and necessary business expenses and would have been deductible. The IRS is advising if you have taken the PPP loan and you have amounts paid that meet the SBA guidelines to constitute forgiveness you will not be able to deduct those expenses. To illustrate, consider that a business with $1,000,000 in ordinary revenue receives a PPP loan for $410,000 which forgiven in its entirety because the funds were used to pay for $300,000 of payroll costs, $100,000 of rent, and $10,000 of utilities.
Absent IRS guidance, some believed the business would have taxable income of $590,000. Now that IRS Notice 2020-32 has been issued, the taxable income will actually be $1,000,000.
While the PPP loan of $410,000 is not taxable itself, the business owner will pay tax on an additional $410,000 due to the disallowance of the expenses. Assuming a tax rate of 37% that is a $151,700 difference in tax liability.
The main thing is until further guidance is provided, you need to make sure you set aside enough money for taxes as a result of the PPP loan.
If you have questions about how the PPP loan affects you and your business, please schedule a consultation with us.