If you have received Paycheck Protection Program loans for your business, there are a few things important to know. In this blog we will explore the tax consequences of the PPP loans from the federal government to businesses.
An eligible recipient may have PPP loan forgiveness in an amount equal to your 1. Payroll costs, 2. Interest payments on any covered mortgage obligation, 3. Payment for any rent obligation, and 4. covered utility payments. Any of these utility, or rent, or mortgage obligations must have been in place before Feb. 15, 2020.
Your covered period would normally have been the 24-week period beginning on the date you took out the loan (and ending no later than Dec. 31, 2020, if that was before the expiration of the 24-week period). Recipients of a PPP loan before June 5, 2020 can elect a shorter 8 week covered period. If you elected to use the 24-week period, you had to maintain payroll levels for each of the 24 weeks in order to qualify for loan forgiveness. If you’re seeking forgiveness of indebtedness, you must verify the amount for which forgiveness is requested, was used to pay employee salaries, make interest payments on a covered mortgage obligation, make payments on a covered lease obligation, or make covered utility payments.
The forgiveness of PPP debt is unique to other cancellation of indebtedness in that it is excluded from gross income. Any net operating losses, credits, capital and passive activity loss carryovers, and basis; however, will not be generally reduced on account of this exclusion.
The IRS has stated, that expenses paid with the proceeds of PPP loans cannot be deducted because of the fact that the forgiveness is excluded from gross income. This results in a tax exempt income, therefore the expenses cannot be deducted without producing a tax benefit. Sounds scary, but for many businesses it’s still worth consideration.
For example: Consider a loan recipient that normally pays $1 million in payroll costs. This recipient then applies and obtains a PPP loan for the maximum amount: $208,333, and uses the loan to pay for covered expenses. Afterwards the loan is fully forgiven. Now, the recipient has $208,333 of payroll and other costs that cannot be deducted. So, even though the forgiven loan proceeds were not taxable income, since they cannot deduct the expenses paid by the forgiven loan – in effect the PPP loan proceeds are in fact taxable by a convoluted, round-about method. In reality, for this recipient, the PPP loan actually resulted in a net benefit even though the loan forgiveness wasn’t considered income.
One situation in which a company might be in worse shape after receiving the PPP loan, is if they don’t qualify for loan forgiveness, for example if they had to lay off their employees, or couldn’t qualify for any of the safe harbors. Then they could end up with debt, troublesome to repay. (Reference paragraphs 2-3 for specifications on keeping records in order to seek loan forgiveness.)
Because of issues, like the above examples, the IRS’s position on this issue has been criticized. Some members of Congress believe to deny the deduction of the PPP covered expenses is inconsistent with the intent that the forgiveness of PPP loans be non-taxable event. As with everything, we are waiting on any changes that might take place, and make it a priority to keep on top of new regulations in order to serve our clients effectively.
One last thing to be aware of. If your business has a PPP loan of $2 million or more, you can expect an audit if you apply for loan forgiveness. However, as things play out, be aware that considering the potential of misuse of funds, audits of smaller borrowers may be a very real possibility. So, our advice, keep good records! It will be worth it; not only when you seek loan forgiveness, but if and when the IRS decides to investigate smaller borrowers as well.