Many business owners have been focused on the CARES Act popular PPP loan program, as of late, as it has potential to help businesses get through economic difficulties brought on by the coronavirus pandemic. The main attraction to a PPP loan is the potential to have the loan partially or fully forgiven if the proceeds are used for qualifying expenditures during the time period specified in guidance from the SBA…but how does deductibility of expenses fit into the equation?

What is the tax treatment of expenses paid using forgiven loan proceeds?

A question mark on this has been the CARES Act’s silence on the tax treatment of expenses paid using forgiven loan proceeds. Would the expenses paid for with PPP loans be deductible if the loan has some level of forgiveness? Of course we could expect that the IRS was going to give an opinion on this sooner or later. That opinion has come out in Internal Revenue Notice 2020-32. In a surprise / no surprise statement, IRS is deeming the expenses paid for by forgiven PPP loans as non-deductible.

What is the impact on businesses?

Before getting too wound up in the notions of fairness, this is going to affect different businesses in different ways. For example, a business that is completely closed will likely not feel an impact because they have zero revenue during the shutdown so the lack of expenses will not change anything. Those businesses will probably still have a Loss for the period of closure due to other non-covered expenses such as insurance.

For businesses that are partially closed this will have a partial impact. Those businesses are probably running at a loss due to decreased revenue. The non-deductible expenses might only bring them to break even or somewhere close, so for these businesses the impact is again negligible.

Businesses that are operating at near full capacity and are experiencing smaller disruptions in employees’ ability to perform their typical job duties, will experience the greatest impact of this IRS ruling. These businesses will actually have higher taxable incomes than usual as a result of receiving tax free loan proceeds but having reduced expenses to offset their revenues.

All these variables lead to a greater need than ever for planning and projecting. There is now more complexity in decisions such as which employees to bring back and when.

Case by case basis

Adding to the puzzle will be the tax positions of each state, California has already announced that they were not allowing forgiven loan amounts to be tax free - which will weigh into the decisions process too. Regardless of the economics, there may even be instances where a business decides to repay the loan and take the expense deductions. However, in almost all instances it will be economically better to have the loan forgiven and pay additional tax if required. The net cash gained will be positive, but business owners and managers do need to be prepared for the additional cash needs that some extra taxation will bring. Everything needs to be considered case by case, there will be no one answer fits all.

What’s a related expense for purposes of non-deductibility?

For taxation purposes, it won’t matter because the tax return reporting will most likely just require a one line lump sum non-deductible expense equal to the amount forgiven from the loan. It’s doubtful that anyone will be required to match up the specific expenses line by line on a tax return as that would actually be detrimental by causing mis-matches with other reporting such as salaries and wages.

How will this work since the forgiven loan amounts might not be known before the end of the year?

We don’t know exactly when the forgiven portion will be known but tax returns are always filed after year end with most small businesses due either March or April 15. If more time is needed, then tax return extensions can be filed to allow taxpayers time to gather complete information.

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