August 25, 2020
Since the CARES Act was introduced at the end of March 2020 and the Paycheck Protection Program (PPP) offered small businesses a lifeline, there have been more questions than answers at different times. One question that has remained top of taxpayers’ minds concerns how – and whether – PPP loan funds are taxed. There are still uncertainties but for the most part, enough guidance has been published to help Atlanta companies navigate the issue. However, it is important to be aware that both Congress and the Small Business Administration regularly issue new updates so there is no guarantee the rules will not change in the future. To help clients, prospects, and others Wilson Lewis has provided a summary of key points below.
Paycheck Protection Program Funding Review
There have been two rounds of PPP loan funding so far: April 3 to June 30, 2020 (minus some lapses in funding and application snafus early on), and July 4 to August 8, 2020. Though some members of Congress expressed a desire to offer additional rounds of PPP funding, to date nothing concrete has been announced. When PPP was originally offered, businesses had eight weeks to spend at least 75 percent of the funds on qualified payroll expenses, leaving the remainder for rent, utilities, and interest. Since then, rules have been relaxed so that more small businesses would be able to participate in the program.
On June 25, 2020, the PPP Flexibility Act extended the covered period from eight weeks to 24 and lowered the payroll expenses threshold to 60 percent. Congress also simplified the calculation for full-time equivalent employees (FTEs), streamlined the application process, and introduced an E-Z loan forgiveness application for qualified borrowers.
Ordinary Debt Forgiveness Tax Consequences
Usually, when a business (or individual) incurs debt for which it is legally obligated to repay, forgiven, or discharged amounts are taxable. This is called cancellation of debt and includes scenarios where the creditor cannot collect, gives up on collecting, or other situations involving property, such as foreclosure. When debt is canceled, the amount must be reported on Form 1040 as “other income” for nonbusiness debt or on the appropriate schedule for business debt. Unfortunately, PPP loan forgiveness is another thing entirely when it comes to the canceled debt.
PPP Loan Forgiveness: An Overview
Generally, if a borrower meets all eligible criteria and uses the funds appropriately, the full amount is forgiven. Businesses must agree to maintain wages and FTEs prior to February 15, 2020, although there are safe harbors for not doing so. For example, if a formerly furloughed employee was reoffered employment but he or she declined, or if gross receipts are more than 50 percent less than the lookback period.
For purposes of tax collection, Question 16 of SBA’s PPP FAQs state that “… payroll costs are not reduced by taxes imposed on an employee and required to be withheld by the employer, but payroll costs do not include the employer’s share of payroll tax. For example, an employee who earned $4,000 per month in gross wages, from which $500 in federal taxes was withheld, would count as $4,000 in payroll costs. The employee would receive $3,500, and $500 would be paid to the federal government. However, the employer-side federal payroll taxes imposed on the $4,000 in wages are excluded from payroll costs under the statute.”
The CARES Act specifically stated that forgiven amounts of PPP loans are excluded from gross income and not taxable. There is a catch that applies to deductible expenses that could still end up costing businesses; except instead of paying tax on PPP funds, the business loses the advantage of certain tax deductions.
Tax Consequences of PPP Loan Forgiveness
For the most part, PPP loan amounts that end up being forgiven are not considered taxable income. Discharged debt from PPP loans should not count toward a business’s gross income for tax purposes but there are limitations to forgiveness. Further, if a business doesn’t spend at least 60 percent of on qualified payroll expenses, loan forgiveness will be reduced. And, if wages are reduced by more than 25 percent at any time during the covered period and/or the FTE count is not restored to pre-February 15, 2020 levels by December 31, 2020, loan forgiveness will be reduced, even if funds were spent according to set thresholds.
If any portion of PPP funds is not forgiven, then the funds become business debt and are repaid accordingly. Loans are not taxable.
There could be other tax consequences, though. Recall from earlier IRS guidance that certain expenses, which are ordinarily deductible, are not permitted to be deducted if they were paid using PPP funds that were later forgiven. For example, expenses like rent, utility payments, salaries, and other types of compensation, debt interest, and employer portions of healthcare and retirement costs cannot be deducted on 2020 tax returns if PPP loan funds were used to pay for them. This could change by the time next tax season arrives, and several bodies, including the AICPA and Congress, have been trying to overturn the ruling.
Contact Us
As with most things related to the PPP matters are in a state of flux because of uncertainty about future program changes, However, now is a good time to begin tax planning to ensure your business is in the best position possible. If you have questions about the information outlined above or need assistance with another PPP loan issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here contact us. We look forward to speaking with you soon.