Stimulus Package Reverses IRS’s Position on Deductibility of PPP Expenses and Other Loan Forgiveness Issues

On December 20th, Congress passed a spending bill, signed by President Trump on December 27th, that includes further coronavirus-related fiscal relief (the “Bill”). There are a number of provisions within the Bill that impact both businesses and individuals. This post focuses on changes made to the loan forgiveness aspects of the Paycheck Protection Program (“PPP”).

Deductibility of Expenses Paid with Forgiven PPP Funds

Earlier this year, in IRS Notice 2020-32 and Revenue Procedure 2020-51, the IRS announced that no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of a PPP loan. The Bill reverses this IRS determination and clarifies that otherwise deductible expenses paid with the proceeds from a PPP loan that is forgiven remain deductible. Additionally, the Bill provides that no tax attributes will be reduced and no basis increase shall be denied by reason of the PPP loan forgiveness. Importantly, this tax treatment applies to all borrowers, including those who have already applied for forgiveness.

Potential Timing Issues

While the deductibility reversal is certainly a win for taxpayers, for partnerships or S corporations that have a loss at the end of 2020, the partners and shareholders of those businesses may not be able to recognize the benefit of such a loss until 2021. Partners and S corporation shareholders can only recognize pass-through losses to the extent of their basis in their partnership interests or S corporation shares. When a partnership’s or S corporation’s PPP loan is forgiven, that business will have tax-exempt income that will flow through to its owners which will increase their basis by an equivalent amount. This basis increase will permit those owners to benefit from the deductible expenses paid with proceeds from the PPP loan.

A timing issue potentially results because this basis increase will likely occur in the year that the PPP loan is forgiven, which for many taxpayers will be in 2021, while most business losses attributable to expenses paid with proceeds from the first round of PPP loans will be realized in 2020. If a taxpayer does not have sufficient basis in 2020 to recognize those losses, then that taxpayer will not recognize the benefit of those losses until the end of 2021 when he or she obtains a basis increase from the loan forgiveness.

Streamlined Forgiveness for Borrowers under $150,000

The Bill delivers streamlined forgiveness for loans of less than $150,000. These borrowers will only be required to submit a one-page online or paper form and will only be subject to audit if they commit fraud or use the proceeds for improper purposes. It appears a small borrower will not be subjected to the required reductions in forgiveness amounts generally caused by slashing salaries or slashing headcount.

Other Loan Forgiveness Issues

The Bill provides taxpayers the ability to double dip in a number of scenarios: for example, receipt of an Economic Injury Disaster Loan advance will no longer be taxable, and any expenses paid with the advance will remain deductible. The same holds true for borrowers of traditional Section 7 SBA loans who had six months of their principal and interest paid pursuant to the CARES Act.

PPP Additional Eligible Expenses

The Bill gives PPP borrowers who have not yet applied for forgiveness the opportunity to spend proceeds on four new types of expenses. Those costs are also eligible for forgiveness, subject to limitation (each of the four expenses are non-payroll costs, and the sum of all non-payroll costs cannot exceed 40% of the total costs eligible for forgiveness). The four new expenses are as follows:

1.) Covered operations expenditures. Payments for any business software or cloud computing service that facilitates business operations, product or service delivery, the processing, payment, or tracking of payroll expenses, human resources, sales and billing functions, or accounting or tracking of supplies, inventory, records and expenses. 

2.) Covered property damage costs. Costs related to property damage and vandalism or looting due to public disturbances that occurred during 2020 that was not covered by insurance or other compensation.

3.) Covered supplier cost. An expenditure made by an entity to a supplier of goods that are: (a) essential to the operations of the entity at the time at which the expenditure is made, or (b) made pursuant to a contract, order, or purchase order that was either (x) in effect at any time before the covered period with respect to the loan, or (y) with respect to perishable goods, in effect before or at any time during the period.

4.) Covered worker protection. These are operating or capital expenditures that are required to facilitate the adaptation of the business activities of an entity to comply with requirements established or guidance issued by the Department of Health and Human Services, the CDC, or OSHA during the period beginning on March 1, 2020 and ending on the date on which the national emergency declared by the President under the National Emergencies Act expires. Eligible costs are those related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to Covid–19.

For more information please contact any member of our Tax Group at KMK Law.

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