The Paycheck Protection Program (PPP) has been a valuable resource for businesses struggling with the economic impact of COVID-19. However, if your business received a PPP loan, it’s important to take tax implications into consideration.
The PPP basics
The Coronavirus Aid, Relief and Economic Security (CARES) Act, signed into law on March 27, 2020, was created to offer financial support to American workers and businesses during the COVID-19 pandemic shutdown. The CARES Act provided up to $349 billion in forgivable loans so that small businesses could keep employees on the payroll and cover approved expenses.
Additional PPP funding was approved in April and discussions have been in the works for additional stimulus funding.
Under PPP, small businesses and other organizations can get loans with an interest rate of 1%. If the loan recipient follows the conditions of the loan, both the interest and the principal can be completely forgiven. The PPP loan must be used by the recipient for the following during the covered period:
- Payroll costs
- Interest (not principal) payments on covered mortgage obligations (for mortgages in place before February 15, 2020)
- Payments for covered rent obligations (for leases that began before February 15, 2020)
- Certain utility payments.
An eligible recipient seeking forgiveness of indebtedness on a covered loan must verify that the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage, make payments on a covered lease or make eligible utility payments.
Cancellation of debt income
While a forgivable loan is an important asset for businesses during this time, tax bills may be impacted. Generally speaking, when a non-PPP debt is cancelled, it results in cancellation of debt (COD) income to the debtor. This affects tax bills. However, PPP debt forgiveness will be excluded from gross income, meaning that tax attributes such as net operating losses, credits, capital and passive activity loss carryovers, and basis shouldn’t be reduced because of the exclusion.
Expenses covered with loan proceeds
According to the IRS, expenses paid with PPP loan funds can’t be deducted as the loans are forgivable without businesses having taxable COD income. As a result, proceeds are tax-exempt income. Any expenses allocable to tax-exempt income are nondeductible, as these deductions would create a double tax benefit.
The IRS’s stance on this matter has been under fire by some, though. Some legislators have claimed that denying deductions for such expenses goes against legislative intent. Congress could enact additional legislation that mandates that the IRS to support deductions for expenses paid with PPP loan proceeds.
Auditing PPP loans
Business owners should keep in mind that the U.S. Treasury and the Small Business Administration has put out that beneficiaries of Paycheck Protection Program (PPP) loans greater than $2 million or more should anticipate an audit when they apply for loan forgiveness. These audits are intended to shelter smaller borrowers from PPP audits based on good faith certifications. However, smaller businesses aren’t wholly exempt from audits; government leaders have declared that audits may take place if misuse of smaller loans is suspected.
If you’ve received a PPP loan and need help coordinating your loan forgiveness application, please reach out for Smolin Lupin for help. Loan forgiveness can be a complex process - you don’t need to handle it alone!