The “deductibility” of PPP expenses paid may make 2020 tax season more costly for startups & small businesses
Any small business or startup that received funding aid through the CARES Act could be in for a surprise this 2020 tax filing season. A CNBC contributor Andrew Osterland recently published an article titled “Here’s why a nightmare tax season is ahead for small businesses” explains that PPP loans are going to make tax planning more complex. In the article Holly Wade, director of research and policy analysis for the National Federation of Independent Business stated “The provisions of the CARES Act are all helpful for small businesses, but they will complicate tax planning efforts for the next couple of years.”
As many small businesses are still in recovery /survival mode from the mandated shutdowns this past summer but this upcoming tax season may bring some more surprises. The pandemic relief legislation called the CARES Act that became law this spring established Paycheck Protection Program loans and the employee retention credit and paved the way for entrepreneurs to turn losses into cash.
However, the aid comes with added tax complexity for 2020 and some pain when it’s time to file in the spring. Your business will need the guidance of a tax advisor for filing this year.
PPP loan expense deductibility issues
Businesses need to be aware of the issue regarding the deductibility of expenses paid for with a forgivable PPP loan. The accounting firm BDO published an article that said that on November 18th, the IRS issued guidance “Notice 2020-32” and “Rev. Rul. 2020-27 ” that basically negates the opportunity to claim a 2020 tax deduction for expenses funded with forgivable PPP loans.
The IRS has confirmed that the loans are eligible for tax-free forgiveness if at least 60% of the proceeds go toward payroll. The shock for many companies is that the expenses covered by PPP loans can’t be deducted on 2020 tax returns. The BDO article states “While it was no surprise that the IRS maintained its position that PPP-funded expenses are not tax-deductible, many borrowers that weren’t expecting to receive forgiveness until 2021, and were counting on being able to deduct the expenses in 2020 and then reverse those deductions when they received forgiveness in 2021.” Well The IRS’ guidance quashed this by stating that so long as the borrower has a reasonable expectation of receiving forgiveness in 2021, the expenses are not deductible in 2020. A Forbes contributor published a pretty useful article on the topic.
The IRS is arguing in it’s issued guidance that PPP loan recipients would be receiving a double benefit by deducting expenses paid for by the government. The IRS publication states that “the purpose of section 265 of the Code is to prevent a double tax benefit.” A recent article in the Journal of Accountancy makes a good argument backed by tax case laws that Notice 2020-32 and Rev. Rul. 2020-27 are not a reasonable application of existing tax law.
Section 265(a)(1) of the Code applies to otherwise deductible expenses incurred for the purpose of earning or otherwise producing tax-exempt income. It also applies where tax exempt income is earmarked for a specific purpose and deductions are incurred in carrying out that purpose. Mr Osterland of CNBC points out that “while it may be technically true, it also effectively makes the loan taxable to the extent that other business income will be more fully taxed.”
Congress is in disagreement
Congress continues to state that the IRS’ position is contrary to the original intent of the PPP loans, which was to provide tax-free funding to businesses in need. Tax-free funding includes not taxing the loans and allowing tax deductions for forgiven expenses.
Tom Sullivan, vice president, small business policy at the U.S. Chamber of Commerce told CNBC “if the top priority is to free up capital for businesses then the government should free up capital, and a double benefit is exactly what Congress intended and the IRS needs to be told that these expenses are still deductible.” Apparently, Mr. Sullivan is currently lobbying Congress to address the situation. According to reporting from the Tax Foundation, on Monday, a bipartisan group of congressional policymakers released two compromise relief bills to address the COVID-19 pandemic, totaling about $908 billion: The Emergency Coronavirus Relief Act and the Bipartisan State and Local Support and Small Business Protection Act. The Tax Foundation article mentions that “the bill would also make the tax treatment of forgiven PPP loans more generous by allowing business expenses paid for by PPP proceeds to be deductible.” As mentioned earlier, that under current law, income that is excluded from taxable income cannot also have associated expense payments deducted from taxable income to prevent a double benefit.
The relationship between PPP and other tax breaks
Now even if this PPP “payroll expense deductibility” issue was to get fixed in a more favorable way for small businesses, there is still a challenge, involving the ability to take advantage of and complying with other tax code changes this year. Victoria Glover, a partner in Deloitte’s national tax office also spoke to CNBC and iterated that “It’s not just that the tax code is complicated, the IRS has issued a lot of guidance this year and taxpayers have to follow all of it.”
Another example she points out, is that companies that received PPP loans will not be able to claim the employee retention credit, a credit that’s equal to 50% of the qualified wages paid to employees — or up to $5,000 per employee — from March 13 until the end of the year. Another option is that employers that chose to take a PPP loan may also choose to defer their share of the Social Security tax through the end of the year. The CARES Act is complex and there are a number of interactions between provisions of the CARES Act.
Ms. Glover explained that “it all depends on the facts and circumstances of each taxpayer.” She further stated that people need to speak to their tax advisors about how parts of the CARES Act interact with each other and the rest of the tax code.
Talk to a Tax Expert
Most medium to large employers use a tax professional, but the smaller the business, the less communications they have with one. Holly Wade, of the National Federation of Independent Business. Said she feels that for small businesses it can be intimidating talking to a CPA and they are not sure what questions to ask exactly. Ms Wade worries that many small business owners will fail to take advantage of the provisions in the CARES Act because they are too daunting to figure out.
The article offers 4 useful questions for small businesses to help them get ready for an end-of-year meeting with a tax professional.
- What should I do or think about to prepare for our meeting? Maintain solid bookkeeping and be sure to document your use of any PPP funding. It’ll make things easier for your CPA or bookkeeper.
- What are some common mistakes small business owners typically make in preparing their taxes? This isn’t the year to go it alone. Know some of the key stumbling blocks for entrepreneurs.
- Which tax changes over the last year might impact my business? The CARES Act rolled out emergency funding for small firms, and it will affect your tax return.
- What are the typical deductions and credits for a business like mine that may apply to me? The write-offs and refundable claims you can make are going to be based on the specifics of your company.
Since this year’s CARES Act relief measures revolve around the tax code, it is recommended that entrepreneurs consult with an accountant to guide them through the 2020 tax year. Take the remaining weeks of the year to get your books and records in order, and contact a tax professional. Don’t wait until next spring. If you have any questions, feel free to contact Huckabee CPA for a complimentary consultation about your tax situation and how to develop strategies to minimize your tax liabilities.