The following update includes important information about PPP loan forgiveness and critical tax planning considerations.
Applying for loan forgiveness
When to apply for forgiveness is a big topic that is being much debated in order to be certain you maximize the amount forgiven. Since there has been some support in Congress for the idea that all PPP loans of less than $150,000 be automatically forgiven, with no application for forgiveness required. If a business with a loan of less than $150,000 were to apply for forgiveness now, and have some, but not all of the loan forgiven, it could cause some confusion if Congress later passed a bill stating that all such loans are automatically forgiven. And, any time and effort spent on the loan forgiveness application, including fees, would have been a waste of time and money. For that reason, if you received less than $150,000 you might consider waiting for further guidance from Congress on this issue before completing the loan forgiveness application.
If you received less than $50,000 or more than $150,000 you should consider moving forward and completing the Loan Forgiveness application. At a minimum, we would recommend you start pulling together the necessary paperwork and determining whether you will need to make additional hires before the end of the year.
Keep in mind, the deadline to apply for forgiveness is ten months after the end of your 8 week or 24 week period. This translates into: “Date of Funding + 24 weeks + 10 months”. Accordingly you should not feel rushed in order to apply immediately.
Deductibility of expenses paid with forgiven PPP loan funds
The IRS has stated in Notice 2020 – 32 that they will not allow a deduction for any expenses that were paid from PPP loan funds that were, or are expected to be forgiven: https://www.irs.gov/pub/irs-drop/n-20-32.pdf. They have followed this up with additional guidance in the form of Rev Rul 20–27 addressing the issue of borrowers who pay expenses in 2020 but whose PPP loan is not forgiven until 2021 https://www.irs.gov/pub/irs-drop/rr-20-27.pdf.
When Congress passed the Cares Act, they included a provision that if the loan is forgiven, the forgiven loan does not have to be included as income. For the IRS to then determine that expenses paid with PPP funds are not deductible accomplishes exactly what Congress had hoped to avoid: A situation where the help they were providing to small business would result in additional taxable income to the business. In our opinion, the IRS’ recent publications are contrary to the intent of Congress.
The American Institute of CPAs, the largest association of CPAs in the country, recently launched a campaign to flood members of Congress with a letter requesting that they pass a new bill that will specifically state that expenses paid with forgiven PPP loan funds be deductible, which would put this matter to rest.
We are hopeful that Congress will pass this new law, however, it is entirely possible that they will not. If that happens, PPP loan recipients will have a choice when filing their tax returns:
• Follow the IRS position and not deduct the expenses paid with forgiven PPP funds. The impact will be that taxable income for 2020 will be increased by the amount of your PPP loan that you expect will be forgiven (in many cases, all of it).
• Deduct all of your expenses, under the expectation that Congress will eventually come out with legislation clarifying the deductibility of the expenses. If you choose to do this, attach a Form 8275 to your return and disclose the fact that you have included deductions on your return that the IRS has deemed nondeductible. By disclosing this fact on your return, you protect yourself against potential 20% substantial understatement penalties that could be imposed if Congress does not later pass the legislation needed.
If you decide not to claim the expenses, per the IRS guidance, it is possible that at that point, if the deductibility were to change then you would need to file an amended return for 2020. Generally you have three years to file a claim for a refund on an amended return.
Alternatively if you claim the expenses despite the IRS’s guidance there is significant risk that you would owe substantial taxes and penalties if Congress does not act.
You have some time to make this decision, and, there is also time for Congress to act and remedy what many view as an error in the wording of the PPP provisions.
Unfortunately it is also made year-end planning extremely difficult and because it is currently impossible to say which way it will go, we are recommending that most clients at least pay in enough taxes via estimates to get caught up to the threshold for the exception to the underpayment based on 110% of prior year taxes. Although there will be some penalties up until the payment is made, it will stop additional penalties from accruing. Should you end up with an overpayment for your 2020 taxes we will simply apply the excess to your 2021 estimates.
This then buys us time to make a decision up until April 15, 2021 and hopefully by then Congress will have acted to clarify the matter. Based on information available at that time you will need to decide whether any additional payments need to be made in order to cover your 2020 tax liability. If the law is not clarified by then, we will recommend that you extend your tax return.
PPP Borrowers might want to extend their 2020 tax returns
Our recommendation for clients that received PPP funds will be to extend your 2020 return until further clarification is provided.
There are a couple of reasons that we’re making the recommendation to do this:
1. If we prepare the return contrary to the guidance provided and it ultimately turns out that there is no change in the law, you will need to include an additional disclosure with your return and you could incur substantial penalties.
2. If there is no change to the law and your return needs to be amended, there will be additional fees for amending the returns.
As more information is released we will continue to keep you informed.