Will Businesses Get Double-Dipping Tax Benefits Under PPP Loans?
On 30th April, the Notice 2020-32 has been issued by IRS. The Notice is targeted to address the deductibility of expenses to be paid by a business with PPP (Paycheck Protection Program) funds for federal income tax purpose. The Notice is to confirm the expenses paid with PPP funds eventually forgiven are not deductible. This notice is followed by the instructions provided by IRS mentioning forgiveness of the PPP loan not being taxable. The sole purpose is to create and maintain uniformity required to avert the taxpayers from receiving a double-tax benefit vetoed by entrenched tax principles and precedents under IRC (Internal Revenue Code) Section 265.
Background of PPP:
The PPP was created as a part of the CARES Act, P.L. 116-136. The PPP is premeditated to assist small-business taxpayers for maintaining the functions and operations of their businesses during the COVID-19 pandemic. The recipients of PPP loan may receive loan clemency on the eligible operating expense paid during an eight-week phase beginning on the date of loan’s origination. Eligible expenses include rent, payroll costs, utilities, and certain payments of the interest on mortgage obligations.
The intent of Trump administration in creating the Paycheck Protection Program (PPP) is to maintain American workforce paid and engaged, as Title 1 of the CARES Act specified. The administration states that the purpose of PPP emergency funding is to endow with eight weeks of cash flow assistance to small businesses through federally guaranteed loans to the employers who uphold their payroll. The purpose is for businesses to utilize the funds to cover costs such as payroll, supply chain disruptions, employee salaries and paid sick leave.
However, the administration carved out a special exemption in the PPP bill that focuses on tax-free forgiveness of the PPP debt as long as the money is spent on qualifying operating expenses. The general interpretation of the Act is that its application would not impact the taxable income of small businesses.
The Coronavirus Aid, Relief and Economic security Act (H.R. 748), also known as CARES Act created the Paycheck Protection Program (PPP), pursuant to which employers of Private and Public Companies may be able to obtain loans (“PPP loans”) for covering business' operating expenses during the COVID-19 pandemic. Under the CARES Act, PPP loans are considered as a safe harbor for being partially or wholly forgiven if the proceeds are optimized to cover certain expenses, and the employer does not fall into the considerations of subject to tax on such loan forgiveness.
The CARES Act, though, did not addressed whether the operational expenses that resulted in PPP loan forgiveness will be considered for deduction for tax purposes. The answer to this question is provided by IRS in Notice 2020-32, released on April 30th. In the Notice 2020-32, the IRS concluded that if the payment of the business expense results in the clemency of a PPP loan, such as rent or payroll costs, those expenses will not be deductible for tax purpose. According to the IRS, this treatment is helpful in preventing a “double tax benefit” and it is consistent with Section 265(a)(1) of the IRC, which states that no tax deduction is obtainable for expenses that are paid by a business with tax-exempt dollars.
Updates on Eligibility for PPP loan:
Treasury has issued new guidance regarding the eligibility for PPP loans. A review of FAQ 31 and the 4th interim final rule has left many business owners bewildered concerning whether the safe harbor to pay off the PPP funds, including the allied strategy to determine adequate resources are applied only to the large public businesses or to everyone.
On April 28th, Treasury issued FAQ 37 that confirmed the rules are applied equally to private and public companies. On the same day, SBA and Treasury issued a joint statement that indicates that all loans over $2 million are going to be reviewed. This left the door opened for reviewing the loans of lesser amounts.
The authorities stated that May 7, 2020 will be considered as a deadline to repay any loan obtained till the date upon any misunderstanding or misapplication of the required certification standards. Businesses are advised to work with their advisory team for establishing contemporaneous documentation, such as in internal memorandum, for supporting the basis that ‘why’ the loan was crucial to support their continuing operations.