Hi Everyone,
As I’ve alerted you before, there is still one huge unknown related to the PPP Program, which would have major ramifications on your 2020 tax bill. Now that the unusually long tax filing season has ended, I thought I’d take some time fully explain what this issue is all about.
To explain, in the CARES Act, Congress said:
For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.
From what we know, lawmakers thought this meant that the PPP loan forgiveness was tax-free for you. You probably thought that too. We did.
But then in late April, the IRS issued Notice 2020-32 that prevents PPP loan recipients from deducting business expenses that were paid using the PPP monies that gave rise to forgiveness (defined payroll, rent, utilities, and interest).
Two things to know here:
- The PPP loan and forgiveness is a good deal even if the expenses are not deductible.
- When the CARES Act was passed, it appears that lawmakers thought the PPP monies were tax-free and had not considered that the expenses paid with the loan proceeds would not be deductible.
Good-Deal Example
ABC Inc., an S corporation, receives a $100,000 PPP loan, spends it all on defined payroll, and the lender forgives the $100,000.
On its 2020 tax return, ABC reports no PPP income (remember, it was tax-free), but it may not deduct $100,000 of payroll expenses. The non-deduction creates $100,000 of net taxable income that ABC, the S corporation, passes on to its sole shareholder, Bob.
Let’s say Bob is in the 45 percent tax bracket when you consider both his federal and state income taxes. Bob pays taxes of $45,000 on this income.
And let’s say that ABC passes to Bob the $100,000 of tax-exempt income. This puts Bob ahead by $55,000 ($100,000 – $45,000).
A good deal—sure!
But with passage of the CARES Act, Congress was not just trying to make this a good deal—it was providing ABC with money for it to remain afloat and continue paying its employees during the COVID-19 pandemic.
What If It’s Like We Thought It Was?
If the payroll were deductible, ABC would be ahead by both the $100,000 and the tax benefit of the payroll being deductible—giving the company a better chance of continuing to pay its employees after the PPP loan and its forgiveness.
Since the S corporation doesn’t pay income taxes, let’s look at Bob. He would have the $100,000 plus the tax benefit of the payroll deduction ($45,000).
Here’s the comparison:
- $145,000 if the PPP is as we thought it was
- $55,000 as the IRS has it now
Unfair—Schedule C Taxpayer Suffers No Tax Bite
To add one more reason to why the business expenses paid from PPP loan forgiveness monies should be tax deductible, consider this: the self-employed taxpayer with no employees has his or her loan forgiven based on his or her 2019 net income.
There’s no spend on payroll.
The self-employed person does not have to spend any PPP monies on interest, rent, or utilities. He or she can achieve full forgiveness in 2.5 months based solely on the 2019 tax return.
In its “you can’t deduct it” notice (IRS Notice 2020-32), the IRS invokes IRC Section 265, but Section 265 does not consider how the PPP treats forgiveness for the self-employed. It applies to expenses incurred for the purpose of earning or otherwise producing tax-exempt income.
For the Schedule C taxpayer, no such expenses to produce tax-exempt income need to be paid to achieve 100 percent forgiveness.
Lawmakers Upset with the IRS
Let’s start with the fact that the IRS has a tough job. In many cases, the IRS is nothing more than a referee. If lawmakers fumble the tax law, the IRS has to call it. No choice.
In a letter to Secretary of the Treasury Mnuchin, Senator Chuck Grassley, chairman of the committee on finance; Senator Ron Wyden, ranking member on the committee on finance; and Richard E. Neal, chairman of the committee on ways and means, jointly stated that the IRS got this wrong and that the intent of the CARES Act was for the PPP to be a tax-free grant.
The IRS has held firm. That puts the ball back into lawmakers’ hands, and now it’s their turn. This is where you come in.
Give Them a Nudge
Congress is working on additional COVID-19 legislation, though talks have now completely stalled, and they’ve all gone on vacation until Labor Day.
While they’re working on their tan, the least we can do is flood their email, voicemail, and fax machines to let them know we support the PPP deductibility bills.
Here is how to do that:
- S. 3612 is the Senate bill to make the PPP forgiveness money used to pay business expenses tax deductible. To express your yea or nay on S. 3612, contact your senators. You can find them at this link: https://www.senate.gov/senators/contact
- H.R. 6821 is the House bill to make the PPP forgiveness money used to pay business expenses tax deductible. To express your yea or nay on H.R. 6821, contact your representative. You can find him or her at this link: https://www.house.gov/representatives
You don’t need to be big and formal about your yea or nay. You can fax, email, or phone and simply say you support or oppose the bill. It’s that easy—and it’s effective.
I’ll keep you posted if either of these bills makes any progress, though it could be a while. In the meantime, I’ll be assuming no PPP expense deductions in the estimated tax calculations that I provide to you.
All my best,
Robert
