The CARES act provided much-needed support to many small businesses through a series of relief initiatives including the opportunity to apply for a loan through the Paycheck Protection Program. Administered by the SBA, the program allowed small businesses to take out loans with the specific goal of keeping employees on the payroll.
If you meet certain retention criteria and use the funds only for eligible expenses, the loan can be forgiven. Eligible expenses include payroll costs, mortgage interest, rent, and utilities. If your lender forgives the loan, they will be reimbursed out of CARES Act funds.
PPP loans can be forgiven in whole or in part. That is, you can ask for forgiveness only for the part of the loan you spent on eligible expenses; if you spent any portion of your loan on other expenses, you’ll have to repay that amount.
Sounds pretty straightforward, but what about taxes? Is a forgiven PPP loan taxable income? Should you deduct the expenses involved in handling the loan? Let’s look at some of these questions.
Is A Forgiven PPP Loan Taxable Income?
The CARES act is clear on this point: The forgiven loan is not taxable income. The hitch is that the Act did not amend the Internal Revenue Code. Twenty-one states and the District of Columbia have what’s known as rolling conformity to the most updated version of the Code, so in these areas the forgiven loan proceeds will most likely not be taxed. In 19 states, however, there is what’s called static conformity, which means the states have to explicitly act to update their conformity to the Internal Revenue Code. In these states, the loans are not yet exempt…and states are hurting for revenue, making this potential source of taxes very attractive. Check the rules for your state.
Essentially, while Congress clearly intended these loans not to be taxed, there’s no guarantee that you won’t have to pay taxes on them and this is something to discuss with your accountant.
Also, the IRS has stated that expenses related to the forgiven loan are not deductible…but expenses related to a loan which is not forgiven are. Which brings us to the next issue.
Will Your Loan be Forgiven by the Next Tax Year?
The answer is: Likely not. You have ten months to apply for forgiveness, although most will likely do so sooner. The lender has to decide within 60 days, and if they turn you down, you have 30 days to request a review. Then the SBA has 90 days from receiving the lender’s decision to pay them back. Lenders will not forgive the loan until they have the money back from the SBA. Given the sheer number of loans (and the fact that the SBA has been ordered to automatically review all amounts over $2 million), the SBA is likely to need the full 90 days or close to it.
Another thing to remember is that the SBA can in fact withdraw loan forgiveness for the next five years. This should happen only if there is an indication that your records were incomplete or there is a suspicion of fraud. However, you should keep all records related to the loan for six years.
This means that if you apply for loan forgiveness on, say, November 15, 2020, your lender doesn’t have to decide until January 15, and then the SBA doesn’t have to review until…April 15. Tax day.
Which means that it is very, very likely that tax day will arrive with you knowing whether your loan will be forgiven. There’s no clear guidance on whether you can wait on deciding to deduct the expenses.
Thus, if you are applying for loan forgiveness, consider also applying for a tax extension so you can wait on filing until you have an answer from the SBA.
Congress may address the thorny issue of deductions on expenses by then, but it’s generally best not to count on that.
How Does This Impact Estimated Taxes?
Many businesses have been paying less in estimated taxes this year, choosing to base payments on projected income rather than the prior year safe harbor.
If you are getting a loan forgiven, then this may result in estimated tax being insufficient. The standard penalty for underpayment is 4% of the amount owed for corporations, which can be significant for larger loans. Thus, you may have to make an estimated tax penalty on the assumption that the loan will be forgiven, knowing that if it is not you will get that money back.
It’s unclear which year the income will be counted for. Also bear in mind that the IRS has the ability to potentially waive underpayment penalties due to a “disaster.” Whether companies will be able to leverage this as an excuse for getting estimated tax wrong this year is, of course, uncertain.
Can You Call a Forgiven Loan a Grant?
It may be possible for some companies to account for a PPP loan as an “in-substance grant” if you have strong reason to suspect it will be forgiven. This may or may not work, and you should talk to your tax advisor. If you can call it a grant, it has an advantage in that it reduces your overall debt and ensures that your ability to meet financial covenants won’t be impacted. This might also positively impact your organization’s credit score.
Make sure to have a conversation with your bank about this too. They may well have advice on the best way to handle things, especially if, like many companies, you got your PPP loan from your current bank.
Ultimately, the PPP has been a lifeline, but it also comes with a variety of tax implications. To get help understanding how it might affect your tax burden and how to best handle extensions and accounting, contact BradyRenner CPAs today.