The Paycheck Protection Program is closed, but one question is arising: Should PPP loan recipients be allowed to take tax deductions for business expenses associated with forgiven PPP loans?
Created by the CARES Act, the Paycheck Protection Program (PPP) has provided loans to 650,000 small businesses, enabling them to meet their payroll — and other business — expenses during the COVID-19 pandemic.
However, a contentious issue has arisen: should PPP loan recipients be allowed to take tax deductions for business expenses associated with forgiven PPP loans?
The Internal Revenue Service (IRS) has said no, but business groups and Congressional leaders strongly disagree with the agency’s stance. Congress has also introduced legislation to expressly make expenses associated with forgiven PPP loans tax deductible.
Read on to see what this development means for small businesses with PPP loans.
Background on PPP loans and loan forgiveness
Established under section 1102 of the CARES Act, the Paycheck Protection Program lets eligible small businesses obtain loans of up to $10 million to cover their payroll expenses and certain overhead costs. The loans come with an interest rate of 1%.
The CARES Act was signed into law on March 27, 2020. Under this original legislation, PPP borrowers could receive partial loan forgiveness if they spent 75% of their loan on eligible payroll expenses — including wages, salaries, tips, and employer-sponsored benefits like health insurance and 401(k). The remaining 25% must be spent on eligible non-payroll expenses, such as rent, mortgage interest, and utilities.
On June 5, 2020, the Paycheck Protection Program Flexibility Act (PPPFA) was signed into law. The PPPFA lowers the required payroll expense amount to 60%. Based on the PPPFA, borrowers can receive partial loan forgiveness if they spend 60% of their PPP loan on eligible payroll expenses and the remaining 40% on eligible non-payroll expenses.
This is just one aspect of PPP loan forgiveness, as employers are required to satisfy other criteria in order to have their loan fully forgiven — including utilizing the PPP funds within 24 weeks of the loan origination date plus maintaining employee headcount and compensation levels.
Although section 1106 of the CARES Act says that PPP borrowers can exclude forgiven PPP loans from their taxable income, the Act is silent on whether the expenses that qualify businesses for loan forgiveness can be written off (like ordinary business expenses).
Since PPP loans are supposed to be used for ordinary business expenses, some small business owners (including those with forgiven loans) anticipated deducting their PPP expenses on their federal tax return. However, the IRS has poured cold water on this expectation.
IRS Notice 2020-32 denies tax deductions for forgiven PPP loans
On April 30, 2020, the IRS issued Notice 2020-32, clarifying “that no deduction is allowed under the Internal Revenue Code (Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the” CARES Act.
The IRS is essentially saying that PPP borrowers cannot have the PPP expenses qualify for loan forgiveness and then turn around and claim those same expenses as tax deductions. In defending the IRS’ position, Treasury Secretary Steven Mnuchin said that businesses aren’t allowed to “double dip.”
Business groups oppose the IRS’ position
On August 4, 2020, a group of over 170 business and trade organizations sent a letter to House Speaker Nancy Pelosi and Senate Majority Leader Mitch McConnell, urging Congress to make a technical correction to fix the tax treatment of forgiven PPP loans.
Among the organizations are the American Institute of CPAs, the American Farm Bureau Federation, the National Association of Home Builders, the Family Business Coalition, the Academy of General Dentistry, and the National Retail Federation.
The group argues that IRS Notice 2020-32 overturns the CARES Act’s intention and that “Congress intended loan forgiveness under PPP to be tax-free.” Further, the group asserts that PPP borrowers would not be receiving a double benefit if allowed to write-off the expenses, and if anything, the IRS’ stance “eliminates any benefit, let alone a double benefit.”
Implications (of the IRS’ denial) for small businesses
- PPP borrowers could face a loss of ordinary business deductions, as they won’t be able to write-off expenses associated with the forgiven portion of their PPP loan.
- According to the business group’s letter, the IRS’ position represents a tax hike of approximately $100 billion and will cause hardship for businesses facing financial setbacks during the COVID-19 pandemic.
The business group also asks some critical questions:
- How will the inability to deduct PPP-related wages as a business expense impact the IRS’ qualified business income (QBI) deduction, which allows eligible businesses to deduct up to 20% of their QBI?
- How will the inability to deduct PPP-related wages affect the Work Opportunity Tax Credit?
- How would PPP borrowers offset their PPP expenses for 2020 with loan forgiveness that occur in 2021?
Ultimately, the business group is requesting that Congress “reaffirm its intent and restore the tax benefits it intended to give distressed Main Street businesses as part of the CARES Act.”
Congress introduces legislative fix
On May 5, 2020, a bipartisan group of senators sent Steven Mnuchin a letter, arguing that IRS Notice 2020-32 runs counter to Congressional intent.
“We believe the position taken in the Notice ignores the overarching intent of the PPP, as well as the specific intent of Congress to allow deductions in the case of PPP loan recipients,” the senators say in the letter.
Then, on May 6, 2020, a bipartisan group of senators introduced the Small Business Expense Protection Act to make clear that expenses paid with forgiven PPP loans are tax deductible. Senator Chuck Grassley, a co-sponsor of the bill, said in a statement:
“When we developed and passed the Paycheck Protection Program, our intent was clearly to make sure small businesses had the liquidity and the help they needed to get through these difficult times. Unfortunately, Treasury and the IRS interpreted the law in a way that’s preventing businesses from deducting expenses associated with PPP loans. That’s just the opposite of what we intended and should be fixed. This bill will do just that.”
But until that — or similar — legislation comes to fruition, PPP borrowers with forgiven loans will need to prepare for possibly fewer business deductions at tax time.