PPP Loan and Taxes
The CARES Act was passed on March 27, 2020 and introduced the Paycheck Protection Program. It allowed small businesses to receive a loan and use it over the following 8 weeks to pay approved expenses. If the loan was used for approved expenses, it would be forgiven, and the borrower would not be required to pay it back. Normally, when a loan is forgiven it must be included in income of the borrower. This is commonly seen when someone has a mortgage foreclosure or credit card debt that is forgiven.
PPP Loan Forgiveness
A unique aspect of the CARES Act is that it specifically allowed for exclusion from income of any loan forgiveness related to a PPP loan. This means a business owner could receive a PPP loan and have that loan forgiven with no impact on their taxable income! While Congress was keen to ensuring business owners would not be required to include the loan forgiveness in income, the deductibility of expenses paid using the PPP loan was left unaddressed. The IRS was quick to act on this and issued a notice in April 2020 stating no deduction would be allowed for expenses paid using any PPP loan that is forgiven.
For example, if a business owner received a $100,000 PPP loan that was later forgiven, that owner would be able to exclude the $100,000 from income but would also have any associated expense from that $100,000 loan disallowed. As justification for their decision, the IRS cited Internal Revenue Code §265(a)(1) which says no deduction is allowed if paid for using tax-exempt income.
Shortly after the IRS notice, many professional accounting organizations, including the AICPA, issued statements asking Congress to address the deductibility of these expenses and urged Congress to issue guidance allowing businesses to take the deductions.
Extension of PPP Loan Program
In June of 2020, Congress passed the Paycheck Protection Program Flexibility Act (PPPFA) extending the time to use PPP loans from 8 weeks to 24 weeks, but again did not address the deductibility of those expenses. Business owners began to realize they may not have their loan forgiven until 2021, however the loan was used to pay expenses in 2020. This begs the question: Are expenses paid using the PPP loan deductible if the PPP loan has not yet been forgiven?
The IRS has answered this question simply, “No.” This means the expenses paid for using PPP loan funds would not be deductible in 2020. In the example above, the resulting effect would be an increase in income of $100,000 which would increase the business owner’s tax liability. In a year where a pandemic has devastated small businesses, this increase in tax could be unaffordable to business owners.
Opponents of the IRS position have argued this violates §265(a)(1), the same section the IRS cited when issuing their notice. If the loan has not been forgiven, there is no tax-exempt income. If there is no tax-exempt income, how can the IRS disallow a deduction claiming it was paid for using tax-exempt income?
It is a conundrum that many business owners will face as the 2020 tax year comes to an end and tax returns must be filed. Barring any further action from Congress, it is unclear if the IRS will hold their position or if a determination will be required from the Courts. Of course, all this would become moot if Congress were to allow a full deduction for any expenses paid for using the PPP loan, overriding the IRS decision in their April 2020 Notice. Rest assured the experts at Murtha & Murtha will continue to monitor this issue to provide the best advice for our clients.