Many small businesses have been approved for and now may have received loans through the Paycheck Protection Program (PPP). The PPP was created as part of the Coronavirus Aid, Relief and Economic Security Act (CARES Act), passed in April, 2020. The PPP loans may not have to be repaid if the funds are used for certain payroll and business expenses over an 8-week period after loan funds are received (see WBL’s blog article on the important considerations and best practices for getting PPP loans forgiven).
Section 1105(a)(i) of the CARES Act specifically excludes from taxable income any portion of a PPP loan that is forgiven. Many businesses understood this to mean that the PPP loans, whether forgiven or not, are tax-free. However, as we have warned, there is precedent for the IRS to disallow certain tax deductions when they are effectively paid for with reimbursed or tax-exempt funds. Sure enough, on April 30, 2020, the IRS issued Notice 2020-32 that affirms our fears. The Notice states that no deduction is allowed for an expense payment “to the extent of the resulting covered loan forgiveness (up to the aggregate amount forgiven) because such payment is allocable to tax-exempt income.” This position results in a backdoor way of taxing the forgiven amounts.
As a simple example of the tax implications of Notice 2020-32, assume a taxpayer received a PPP loan of $1.5 million, of which $1 million will be forgiven under the rules set out in the CARES Act. Further, assume the taxpayer has a 35% marginal income tax rate. By disallowing $1 million in deductions under the IRS position, the benefit of the $1 million loan forgiveness is reduced to $650,000.
For nonprofit organizations that do not pay taxes on income and do not deduct expenses, this Notice will have no impact.
The American Institute of Certified Public Accountants (AICPA) of which Williams Benator & Libby is a member, is formally challenging the IRS position. The AICPA’s position is that disallowing deductions in connection with the PPP loan forgiveness is contrary to Congress’ intent. It is currently seeking legislative clarification.
In the meantime, we recommend that businesses adjust their cash flow planning related to the PPP and set aside a reserve for resulting taxes (due to disallowed deductions).
Like everything related to the coronavirus pandemic and the PPP, this is a fluid situation. We will continue to monitor the news coming out of Washington D.C. and share updates with you. Until then, keep guessing.