Caution: So far, your PPP-related expenses are NOT tax-deductible
When lawmakers passed the Paycheck Protection Program, the goal was to provide cash for businesses hurt by the COVID-19 pandemic and give them a fighting chance to survive.
It also helped employees, since companies could spend PPP loans on payroll expenses, as well as rent, mortgage interest and utilities. With this in mind, many small businesses paid employees, using PPP loans that the federal government said were forgivable as long as companies met the spending guidelines.
But an IRS interpretation in April – and backed up in May by Secretary Treasury Steven Mnuchin – stated payroll and other expenses paid with forgiven PPP loans, will not be tax deductible.
“The money coming in the form of a PPP loan is not taxable. So, if the money that is coming is not taxable, you cannot double-dip,’’ Mnuchin said in May. “You cannot say that you are going to get deductions for workers that you did not pay for.”
This stance could be devastating for small businesses that kept employees on and now see the benefit of the PPP program lessened by the IRS.
We believe, as does the American Institute of Certified Public Accountants that Congress did not intend to deny the deductibility of expenses paid under the PPP program.
The federal tax impact of PPP non-deductibility
Assume a $1 million PPP loan to an S corporation with a single owner in the 37 percent tax bracket.
Should the expenses paid with the proceeds from the forgiven $1 million PPP loan not qualify as a deduction, the business would owe an additional $370,000 in federal taxes. Thus, the actual economic benefit to the taxpayer in that instance would be $630,000.
However, if the expenses paid with the PPP forgiven loan proceeds are tax-deductible, the total economic impact to this taxpayer would be $1,000,000 in loan proceeds (that ultimately are never repaid as the loan is forgiven), plus an additional $370,000 in tax savings.
Especially for businesses struggling to survive during the pandemic, not having to pay $370,000 in taxes for PPP-related expenses is significant.
Pennsylvania Department of Revenue position
Pennsylvania will likely treat the forgiven portion of the PPP loan as taxable income and therefore treat the related expenses as deductible, creating a net-zero effect. This tax treatment is less beneficial if the forgiven PPP loan is tax deductible.
However, tax rates at the state level are significantly less than the federal and would create a smaller tax burden.
On August 4, AICPA and more than 170 businesses and trade organizations wrote a letter addressed to House Speaker Pelosi (D-Calif.) and Senate Majority Leader Mitch McConnel (R-Ky.) “strongly encouraging’ them to address the tax treatment of forgiven PPP loans.
“Denying the correct tax treatment of these loans will result in hardship for many struggling businesses,’’ the letter stated. “These businesses have already spent the loan proceeds keeping employees on payroll and meeting other necessary costs.”
Unfortunately, Coronavirus Aid, Relief, and Economic Security (CARES) Act does not address whether deductions are allowable for payments of eligible expenses by a recipient of a forgiven PPP loan.
If the IRS’s current position is reversed, businesses issued a PPP loan will see a smaller effective tax rate – meaning a higher total cost to the government. Should the IRS position stand, however, businesses may again be concerned about cash flow when they determine how much they will owe on April 15, 2021.
There is much discussion among politicians on this issue. Many believe Congress will reverse the IRS’s current interpretation, but there are no guarantees. We will all have to wait and see.
Garrett Ofenloch is a supervisor with Boyer & Ritter LLC, where he supports the firm’s Business Services, and Small and Entrepreneurial Business Consulting groups. For questions, reach out to your Boyer & Ritter representative or reach Garrett at 717-761-7210 or firstname.lastname@example.org.