The only certainty in 2020 seems to be whatever you think you know about the Paycheck Protection Program (PPP) changes like the wind.
Established by the CARES Act (signed into law in March 2020), the PPP provided loans to eligible small businesses. If the borrower used the loan proceeds to pay certain eligible expenses, an amount of the loan up to such eligible expenses would be forgiven under the law, and such forgiveness would not be treated as taxable income to the borrower.
In April 2020, the IRS issued Notice 2020-32 explaining a deduction is not allowed for expenses where proceeds are effectively tax exempt, as is the case with the loan forgiveness. This would mean the loan proceeds received by businesses will be taxable since the expenses paid with those proceeds would be disallowed in determining taxable income.
This is a consistent position of the IRS, as expenses associated with tax-exempt investment income are not deductible.
Alternatively, the other argument in Notice 2020-32 is that the expenses are not tax deductible, because prior case law and published rulings essentially deny deductions for otherwise deductible expenses for which “the taxpayer receives a reimbursement.”
A second issue relates to economic performance. Economic performance states that a taxpayer is able to deduct expenses associated with a liability such as a loan, whereby the amount of the liability is unconditionally fixed. Upon review of the PPP loan document language, one finds the note to include language such as “The Note is subject to partial or full forgiveness, the terms of which are dictated by the SBA, Interim Final Rule RIN 3245-AH34, subsequent SBA guidance, the Code of Federal Regulations, the PPP, and all related rules, laws, regulations, and guidance, as may be amended from time to time (the “Forgiveness”).”
The fact the loan is subject to partial or full forgiveness is enough to question whether or not it is unconditionally fixed. It is our belief it is not unconditionally fixed and therefore, the expenses will be disallowed based on Notice 2020-32.
Finally, there is possible reliance on the Bliss Dairy case, which for the sake of brevity draws the following conclusion, “until a taxpayer obtains forgiveness there is no tax exempt income” and IRS Notice 2020-32 does not apply until there is tax-exempt income. The problem with this court case is the American Institute of Certified Public Accountants (AICPA) made an inquiry in regard to forgiveness occurring after year-end and the impact on the expenses paid with PPP monies. According to Mr. Edward S. Karl of the AICPA, “Treasury officials generally stated that if a borrower has a reasonable expectation of loan forgiveness, the expenses can’t be deducted to the extent paid by the loan. That’s true regardless of when the loan is forgiven.”
So what’s a business to do? Here are the options:
- Pay the tax on the disallowed expense (not optimal).
- Defer the tax on the basis of the Bliss Dairy case (not certain it will withstand an audit challenge).
- Place your business tax return on extension and await more guidance.
Congress may act on this issue with the relief being granted retroactively, as bills have been proposed by chairs of both tax committees and have bipartisan support. If this occurs, the entire discussion above for most businesses is moot.
Given the environment in Washington, we are not hopeful there will be a bill in time for the filing of most business tax returns. If Congress does not act, many businesses may find the relief of the PPP funding will be met by the possible nightmare of having to find the funds to pay the taxes.
Need help navigating Paycheck Protection Program loan forgiveness? Call us at (973) 301-2300 or reach out — we’re here to help.