Our firm continues to stay on top of the Paycheck Protection Program (PPP) and its impact on our business clients, and individual owners of flow-through entities. With some very timely guidance, the U.S. Treasury Department and IRS released direction clarifying the tax treatment of expenses where a PPP loan has not been forgiven by the end of the year, which is most of our clients.
Background Information on PPP
On March 13, 2020, President Trump declared the ongoing Coronavirus Disease 2019 (“COVID-19”) pandemic of sufficient severity and magnitude to warrant an emergency declaration for all states, territories, and the District of Columbia. With the COVID-19 emergency, many small businesses nationwide were experiencing economic hardship as a direct result of the federal, state, tribal, and local public health measures that were being taken to minimize the public’s exposure to the virus. These measures, some of which were government-mandated, have been implemented nationwide and include the closures of restaurants, bars, and gyms. In some cases, other measures such as stay-at-home orders were implemented, resulting in a dramatic decrease in economic activity as the public avoided malls, retail stores, and other businesses.
On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) (Pub. L. 116-136) to provide emergency assistance and health care response for individuals, families, and businesses affected by the coronavirus pandemic. The SBA received funding and authority through the CARES Act to modify existing loan programs and establish a new loan program to assist small businesses nationwide adversely impacted by the COVID-19 emergency.
Section 1102 of the CARES Act temporarily permitted the SBA to guarantee 100 percent of 7(a) loans under a new program titled the “Paycheck Protection Program.” Under the PPP, the borrower must use loan proceeds for certain qualifying expenses, including payroll costs, payments of covered rent obligations, and covered utility payments. Section 1106 of the CARES Act provided for forgiveness of up to the full principal amount of qualifying loans guaranteed under the PPP.
On April 24, 2020, the President signed the Paycheck Protection Program and Health Care Enhancement Act (Pub. L. 116-139), which provided additional funding and authority for the PPP. On June 5, 2020, the President signed the Paycheck Protection Program Flexibility Act of 2020 (Flexibility Act) (Pub. L. 116-142), which changed provisions of the PPP relating to the maturity of PPP loans, the deferral of PPP loan payments, and the forgiveness of PPP loans. On July 4, 2020, the President signed into law S. 4116, which reauthorized lending under the PPP through August 8, 2020 (Pub. L. 116-147).
Deductible or Not Deductible, that is the Question?
According to the IRS, since businesses are not taxed on the proceeds of a forgiven PPP loan, the qualifying expenses are not deductible. The IRS rationalizes this position by claiming that this results in neither a tax benefit nor tax harm since the taxpayer has not paid anything out of pocket.
In its recent ruling, the IRS ultimately concluded that if a business reasonably believes that a PPP loan will be forgiven in the future, qualifying expenses related to the loan are not deductible, whether the business has filed for forgiveness or not. Therefore, the IRS encourages businesses to file for forgiveness as soon as possible.
According to the IRS, in the case where a PPP loan was expected to be forgiven, and it is not, businesses will be able to deduct those expenses in the future.
In sum, although this guidance represents much-needed guidance and clarity, it was not unexpected. We have been advising our clients for some time to ensure they are planning for the expectation that certain expenses paid related to the PPP will not be deductible and therefore will result in an increase in tax liability. But, let’s also remember that each of the businesses and their owners benefited tremendously from the use of the PPP loan proceeds. We are working diligently to stay on top of these changes, and will follow-up on any additional guidance.
We would encourage you to review the IRS Revenue Ruling here.
Vince Nardone is Partner-in-Charge of Walter | Haverfield’s Columbus office. He serves as a business advisor to owners and executives of closely-held businesses, counseling them on business planning, tax planning and controversy, cash-flow analysis, succession planning, and legal issues that may arise in business operations. Vince can be reached at 614-246-2264 or firstname.lastname@example.org.