June 10, 2020
The Paycheck Protection Program (PPP), part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, provides loans to eligible businesses to cover payroll and certain other expenses. The U.S. Small Business Administration (SBA) guarantees the loans, and a portion of each loan is forgivable. While the CARES Act specifies that forgiven loan amounts are not included in a business’ taxable income, it does not address whether the expenses paid by the forgiven loan are tax-deductible. The IRS has announced that businesses receiving PPP loan forgiveness cannot deduct these expenses.
What is the Paycheck Protection Program?
Section 1102(a) of the CARES Act amends § 7(a) of the Small Business (SB) Act, codified at 15 U.S.C. § 636(a), to establish the PPP. Eligible businesses may receive loans of up to $10 million from the SBA. The purpose of these loans is to allow businesses to maintain workers on payroll and cover other expenses from February 15 to June 30, 2020. The CARES Act caps interest rates for these loans at four percent, and defers all payments for six months to one year.
What Expenses Can Businesses Pay with PPP Loans?
The SB Act, as amended, defines “allowable uses of covered loans” to include:
– Payroll expenses, salaries, commissions, and other compensation to employees;
– Continuation of employee benefits;
– Rent and utilities; and
– Interest on mortgages and other debt incurred prior to February 15, 2020.
How Can a PPP Loan Be Forgiven?
Section 1106(b) of the CARES Act allows forgiveness of a PPP loan in an amount equal to the sum of certain “costs incurred and payments made” during an eight-week “covered period” that begins on the loan origination date:
– Payroll expenses;
– Mortgage interest; and
– Rent and utility payments.
Suppose a business received a PPP loan in the amount of $100,000 on April 15, 2020. The eight-week “covered period” for the purposes of loan forgiveness would extend to June 10. During that time, the business:
– Maintained payroll in the total amount of $80,000 for its entire staff;
– Paid $10,000 in rent; and
– Paid $7,500 in utilities.
The business would be eligible for forgiveness of $97,500, and would only be obligated to repay the balance of $2,500. The amount of loan forgiveness decreases, however, if the business cuts wages or salary.
Inclusion in Taxable Income and Deductibility of Expenses
In the example above, forgiveness of $97,500 of a $100,000 loan might ordinarily count as $97,500 in taxable income, since it is money received by a business that they do not have to pay back. Under § 1106(i) of the CARES Act, however, the amount of a PPP loan that is forgiven is excluded from taxable income.
This raises an important question about whether the business can deduct the $97,500 in expenses from its taxable income. Typically, business expenses like payroll, rent, and interest are deductible. The CARES Act does not specifically address this, but the Internal Revenue Code (IRC) does.
Section 265(a)(1) of the IRC states that otherwise deductible expenses are not deductible if they are “allocable to one or more classes of income…wholly exempt from the taxes imposed by this subtitle.” The IRS has cited this section in finding that expenses paid with forgiven PPP loan funds are not deductible.
The tax advisors at the Enterprise Consultants Group are available to help you with your payroll tax-related questions. Please contact us today online or at (800) 575-9284 to schedule a consultation with a member of our team.