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You May Not Get Your Cake and Eat It Too

As “small businesses” scramble to get the second round of Payroll Protection Program (PPP) loans, the IRS just released a notice that apparently takes away one of the key perceived benefits of the program. The PPP provides loans to small businesses that are to be used to support paying compensation and other specifically permitted expenses. Beyond the very favorable loan terms (1% interest rate, simplified borrowing process, no personal guarantees), the loans also contain a “forgiveness” provision that may essentially convert them to a grant and not a loan that has to be repaid.

The CARES Act provides that borrowers who pay certain qualified expenses could have some or all the PPP loan forgiven. The CARES Act further provides that the amount forgiven would be excluded from taxable income! Thus, not only free money but free non-taxable money!

The business community took the wording and talk to heart and ran with it – government money (non- taxable) to pay ordinary and necessary business expenses (deductions). This scenario would create an added tax benefit beyond the funds. For example, if a small business received a $200,000 loan and used it to pay $200,000 of salaries and benefits to employees and had the loan forgiven the result was thought to be:

 

Cash Flow

Taxable income (loss)

PPP loan (assume forgiven)

200,000

None

Salaries and expenses

-200,000

-200,000

Net impact

0

-200,000

Under this example, the business would get the tax benefit of the deductions which would reduce its other taxable income. Depending on their tax structure and other circumstances, the income tax savings might range from 21-37% of the net impact.

IRS says, “Not so fast!”

In a notice just released (Notice 2020-32), the IRS states that if the PPP funding is partially or fully forgiven, then the expenses paid from the “tax-exempt” funds CANNOT be deducted. They lay out the technical argument that can be boiled down to “(t)he purpose… is to prevent a double tax benefit”.

The recast example above would look like:

 

Cash Flow

Taxable income (loss)

PPP loan (assume forgiven)

200,000

None

Salaries and expenses

-200,000

None

Net impact

0

0

 

From a technical tax perspective, this result may sound logical but you can expect a huge outcry from the business community, tax attorneys and lobbyists who felt one thing was promised and now is being changed. You can expect this will go back to the Congress and/or the courts and may not get fully resolved for a while.

What should the business do now?

The PPP is still a great opportunity to keep the business going during these unprecedentedly difficult and uncertain times. Even if the IRS approach prevails, the survival of the business is the key issue for the short run. Tax consequences are always important and if the business was making borrowing and spending decisions based on the expected tax arbitrage, then you may need to reevaluate your circumstances.

The rules to the PPP (and life in general these days) continue to morph so expect changes. We are here to help so do not hesitate to reach out and ask your questions and concerns.

About the Author

James Cole is a Tax Partner at BST & Co. and has over 25 years of public and private financial, tax and accounting experience. Over the course of his career he has built a strong reputation for expert, current technical knowledge in the constantly changing areas of corporate, partnership and individual taxation While Jim’s tax background is extensive and broad, he has particular expertise in the real estate and medical practice areas, as well as working with closely-held businesses and their owners, providing services ranging from income tax planning strategies to merger and acquisition consulting, ownership transition, and estate planning.


Posted on May 21, 2020 at 4:40 PM