On April 30, late in the evening -- when few people were likely paying attention -- the IRS released guidance
that essentially nullified much of the benefit of the Paycheck Protection Program (PPP) created under the CARES Act. It stated that those who receive PPP may not receive tax deductions for using those funds to pay expenses. That includes expenses like payroll and rent, the very point of the PPP.
Congress specifically drafted the legislation so that small businesses could receive PPP loans without having to count it as taxable income. That makes the IRS' move all the more stupefying. And it could cost some small businesses on the brink more than they can afford.
How Much Could It Cost Businesses?
That cost isn't theoretical. It's actually fairly easy to quantify.
Let's say a small-business owner requests and receives $600,000 to cover payroll for the 10 weeks where he or she is covered by the PPP. If they can't deduct that amount as expenses, that means their federal tax burden clocks in at a rate of 37%.
That equates to a $222,000 increase in their taxable income. Meaning the effective tax-free benefit of the loan is $378,000, not the $600,000 intended by the law.
PPP Loan Forgiveness is Taxable Income per IRS
The IRS has released guidance (Notice 2020-32) stating that expenses related to forgivable loans through the Paycheck Protection Program (PPP) won't be tax-deductible.
Under the PPP, small businesses wouldn't have to repay the low-interest loan they received as long as the loan went to essential expenses such as maintaining payroll, utilities and rent.
Under the CARES Act, the PPP loan forgiveness is not counted as taxable income. But the IRS said in its guidance that expenses that result in forgiveness of a PPP loan are not tax-deductible in order to prevent a "double tax benefit."
Unless Congress overrides the IRS's argument, the result is that the disallowed deductions will effectively create the same amount of taxable income you would expect if the deductions had been allowed, but the debt forgiveness was taxable.
Since Congress was clear in their intent that the debt forgiveness should not create taxable income, hopefully when they learn of the IRS's argument, they will issue guidance or even new tax law that allows these expenses to remain deductible. But until then, taxpayers should assume that any debt forgiveness from a PPP loan will effectively be taxable income.