From what we know, when lawmakers originally passed the Paycheck Protection Program (PPP), they thought that under its provisions
- you did not pay taxes on the forgiveness amount, and
- you also could deduct the expenses that you paid with the PPP money.
Fly in the Ointment
In late April, the IRS issued Notice 2020-32, which asserts that PPP loan recipients may not deduct business expenses paid using the PPP monies that gave rise to forgiveness (defined payroll, rent, utilities, and interest).
In a May 5, 2020, letter to Secretary of the Treasury Steven Mnuchin, Senator Chuck Grassley (chairman of the Committee on Finance), Senator Ron Wyden (ranking member on the Committee on Finance), and Congressman Richard E. Neal (chairman of the Committee on Ways and Means) jointly stated that the IRS got this wrong and that the intent of the CARES Act was for the PPP to be a tax-free grant.
The IRS was unmoved by the lawmakers’ letter. The IRS position was clear: no deduction for the expenses paid with the PPP money. The IRS understood that perhaps lawmakers didn’t mean that to happen, but in the eyes of the IRS, the way that the lawmakers enacted the law created the problem. To fix it, lawmakers simply need to pass a new law.
Frankly, we thought that lawmakers would pass a new law and take care of this problem. But no, that has not happened.
New Nails in the Coffin
On November 18, 2020, the IRS drove two new nails into the coffin regarding deductions for PPP monies that were forgiven and spent on payroll, rent, interest, or utilities.
Nail 1. In Revenue Ruling 2020-27, the IRS ruled that you may not deduct expenses paid with the PPP loan monies if you have received or expect to receive forgiveness of those loan monies.
Nail 2. In Revenue Procedure 2020-51, the IRS set forth safe-harbor procedures to follow if your PPP forgiveness is subsequently denied or if you decide not to apply for forgiveness.
With the rulings described above, the IRS has clarified its position and clearly stated to lawmakers: if you don’t like the non-deductibility of expenses paid with PPP monies, change the law.
Effect on You
You continue to come out ahead if you can’t deduct some or all of the expenses you paid with the PPP money.
Remember, you don’t pay taxes on the income. You just can’t deduct the expenses.
Example. John’s C corporation gets a $100,000 PPP loan that is forgiven, making it not taxable. With this money, the corporation covers $100,000 of its payroll, which is not deductible, costing the corporation $21,000 in taxes.
The corporation is ahead by $79,000.
On the other hand, if the expenses were deductible, the corporation would be ahead by $121,000 because it would have the $100,000 in cash plus the $21,000 tax benefit from the deduction. That’s a $42,000 swing for this corporation.
Proprietors and Partners
The self-employed taxpayer with no employees has his or her loan forgiven based on his or her 2019 Schedule C net income. There’s no spend on payroll.
In its three “you can’t deduct it” judgments (Revenue Ruling 2020-27, Revenue Procedure 2020-51, and Notice 2020-32), the IRS gives no guidance on how it will treat the money spent by Form 1040 Schedule C filers other than any spend on rent, interest, or utilities—which, of course, would be non-deductible. But most proprietors with no employees obtain full forgiveness with no spend on rent, interest, or utilities.
For now, it appears Form 1040 Schedule C filers have the equivalent of the Monopoly game’s “get out of jail free” card.
The same is true for partnerships and distributions to partners.
Potential Trouble for Your Section 199A Deduction
Based on what we know at the moment, if your Section 199A deduction depends on payroll, your inability to deduct payroll costs paid with PPP money will cost you some of your Section 199A deduction.
What to Do Now
Join with hundreds of thousands of business taxpayers and tax professionals who are urging lawmakers to fix the non-deductibility issue. To help encourage the action you desire (whether you’re for or against deductibility), get in touch with your state’s lawmakers.
- S. 3612 is the Senate bill to make the PPP forgiveness money used to pay business expenses tax deductible. You can find them at this link: https://www.senate.gov/senators/contact.
- H.R. 6821 is the House bill to make the PPP forgiveness money used to pay business expenses tax deductible. You can find him or her at this link: https://www.house.gov/representatives.
You don’t need to be big and formal about your yea or nay. You can fax, email, or phone and simply say you support or oppose the bill. It’s that easy—and it’s effective. Do it.