June 24, 2020
Congress established multiple programs to assist individuals, families, businesses, medical providers, and others in the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The Paycheck Protection Program (PPP) provides loans to small businesses to cover certain operating expenses. The portion of a PPP loan used to pay covered expenses is fully forgivable, with no resulting tax liability. This created uncertainty, however, with regard to whether those same expenses are considered tax-deductible. IRS Notice 2020-32 resolves this uncertainty. Businesses receiving PPP loan forgiveness may not deduct expenses covered by this provision of the CARES Act, and if a business claims those expenses as deductions, they may not be eligible for loan forgiveness.
What Is a PPP Loan?
The PPP appears near the beginning of the CARES Act, in § 1102. The program provides loans to small businesses to cover payroll expenses, rent and mortgage payments, utilities, and other costs needed to keep the business running for the period from February 15 to June 30, 2020. The primary purpose of these loans, as indicated by the name of the program, is to enable businesses affected by the COVID-19 pandemic to keep their employees paid.
When Can a PPP Loan Be Forgiven?
Under § 1106(b) of the CARES Act, businesses may obtain forgiveness of all or a portion of the loan. The forgivable amount is equal to the total spent during the “covered period,” an eight-week period beginning on the loan origination date, for expenses directly related to payroll, rent, utilities, and mortgage payments. The forgivable amount is reduced if the business lays off employees or cuts wages.
If a business received a $100,000 PPP loan on April 10, 2020, its covered period would end on June 5. During this time, let us suppose that the business kept its entire workforce at full pay, at a cost of $75,000. The business also paid $12,000 in rent and $5,000 in utilities during the covered period. A total of $92,000 would be forgivable, meaning that the business would only be obligated to repay $8,000.
The amount of loan forgiveness cannot exceed the principal of the PPP loan, according to § 1106(d)(1). Suppose the business described above paid $80,000 in payroll, $15,000 in rent, and $6,000 in utilities during the covered period. The total amount of covered expenses, $101,000, would exceed the loan principal by $1,000. The entire principal amount would still be forgivable.
Is PPP Loan Forgiveness Considered Taxable Income?
Normally, loan forgiveness is considered a taxable event for the purposes of federal income tax. Section 1106(i) of the CARES Act, however, specifically states that PPP loan forgiveness is not part of a business’ gross income.
What About Deductible Expenses?
Since the PPP loan funds used to pay covered expenses are not included in gross income, the IRS has determined that those expenses are not tax-deductible. Using the business described earlier as an example, it would normally be able to deduct the $17,000 it spent on rent and utilities from its gross income. The PPP loan money that it used to pay those expenses, however, was never included in its gross income. The expenses are therefore not deductible.
If you have tax-related questions about the CARES Act, a PPP loan, or other business or personal matters, the tax advisors at the Enterprise Consultants Group can answer your questions and discuss your rights and options. Please contact us online or at (800) 575-9284 today to schedule a consultation to see how we can help you.