Business owners are wondering if their Paycheck Protection Program (PPP) loan will affect their deductions when they file their tax returns and what portions of the loan will be deductible. Here is an update from our COVID-19 team leaders on this issue.
Late yesterday evening, the IRS released guidance regarding the deductibility of certain expenses businesses have paid with the loan proceeds received through the Payroll Protection Program (PPP). In Notice 2020-32, the IRS states that businesses that use the loans to pay otherwise deductible costs and receive loan forgiveness to the extent of the expenses, will not be permitted to use those expenses to offset their taxable income.
Ordinarily, a business would otherwise be permitted to offset taxable income with the type of expenses for which the PPP loans were meant to help fund. These expenses include items such as payroll costs, rent expense, utilities, etc., which are generally deductible.
In the CARES Act, Congress allowed for the forgiveness of all, or a portion of, the PPP loan amount to the extent the loan proceeds were used on eligible expenses during the 8-week period following disbursement and the borrower satisfies other PPP forgiveness criteria. With this recently released guidance, the IRS states that to the extent a business utilizes otherwise deductible expenses to receive loan forgiveness, they will not be permitted to claim those same expenses as deductions.
Here is an example:
A business receives a loan through the PPP in the amount of $100,000. During the 8-weeks following disbursement, the business spends $80,000 on eligible payroll costs and $10,000 on eligible rent expenses. The remaining $10,000 is spent of payroll and rent, however it is not paid or incurred during the 8-week covered period.
The business properly applies for and receives loan forgiveness in the amount of the $90,000 of eligible expenses spent in the covered period. When filing its return for the 2020 tax year, the business will not be permitted a deduction for the $80,000 in payroll and $10,000 in rent that was spent during the covered period and subsequently utilized to receive loan forgiveness.
The business will be allowed to deduct the $10,000 of otherwise deductible expenses spent outside of the covered period, since they did not result in forgiveness of the loan.
Additionally, the IRS reinforced the position put in the CARES Act that the income associated with the forgiveness of the loan issued through the PPP is not included in a business’s gross income. Effectively, this creates a “tax neutral” position for the businesses who receive loan forgiveness, since they are not forced to recognize income as a result of the cancellation of the debt from the Program. At the same, they time do not receive the benefit for expenses that stem from this tax-exempt income.
As with other aspects of the PPP loan program, proper documentation will be of the utmost importance. Employers should consult with their advisors regarding what information should be retained in order to support potential deductions and adjustments.
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