The IRS is creating tax planning challenges with regards to the PPP forgiveness. They have indicated the expenses associated with the funds, even when utilized appropriately, are not deductible as an expense. This is a way of stating the forgiven PPP funds are taxable. If this continues to be the case, it will be important to know what to do to minimize your tax liability.
Under the CARES Act, Congress said that the PPP (Paycheck Protection Plan) loan would be tax free. Initially, it is a loan but then you can apply for forgiveness and it therefore becomes a grant. Congress specifically said the grant was tax free. This makes sense given that businesses were struggling to survive, not lay off employees during the shutdowns and determine how this will impact long-term.
However, the IRS rules indicated that the money could be tax free, but you were not allowed to take the deduction thereby decreasing your expenses and increasing your taxable income.
The IRS indicated that if you expect to receive forgiveness, you must reduce your expenses. For example, let us say your Company received $100,000 in PPP funds. After your period was up you applied for forgiveness for the entire amount since you utilized it according to the regulations. The accounting of the loan is to zero out the loan and reduce the deductions by $100,000. In essence, the loan has now become taxable by reducing the allotted expenses. That is how debt forgiveness typically works – if you are released of a debt it becomes taxable income. This was not how Congress intended this particular program to work.
Congress has indicated they would correct this issue, but then they got busy with other things and a lot of partisan politics. The end results are that nothing has happened thus far.
Now we have a new ruling from the IRS (Revenue Ruling 2020-27), and it is not good news.
The IRS has now indicated that companies cannot deduct the expenses paid or incurred in 2020 if companies reasonably expect at year-end to receive forgiveness of the debt in 2021. In other words, even if the PPP is still a loan in 2020, you must account for it as it has been forgiven and pay tax on those funds. Many questions have arisen if companies should wait to apply for forgiveness. With this new ruling, waiting does not appear to provide a benefit for 2020.
We are hopeful the current rulings will change to continue to help businesses who have struggled during the pandemic. We are assuming this will not change by year-end and are planning accordingly.
What can you do now to pay less tax and plan accordingly? Contact us now to get your year-end tax strategy in place!