PPP: Time for small-business owners to raise hell? Probably.
As you read this, it’s likely that your lawmakers are working on the next Payroll Protection Program (PPP) package. And hopefully, in this next package, they will include a provision that allows you to deduct business expenses that you pay with your PPP money. Yes, you read that correctly: Current IRS policy & procedure states that your business CANNOT use any of the expenses paid with forgiven PPP money as a deduction on the upcoming business tax returns. Does that unexpectedly affect your small business? Most likely, yes. Read on, dear small-business owner.
In the CARES Act, Congress said:
“For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.”
From what we all know, at the time the CARES Act was written, lawmakers thought this meant that the PPP loan forgiveness was tax-free for you. You probably thought that too. We did. We all did. That was the promise, plain and simple.
But then, in late April 2020, the IRS issued Notice 2020-32 that prevents PPP loan recipients from deducting business expenses that were paid using the PPP monies that gave rise to forgiveness (these expenses would be defined payroll, rent, utilities, and interest).
Two things to know here:
The PPP loan and forgiveness is a good deal even if the expenses are not deductible.
When the CARES Act was passed, it appears that lawmakers thought the PPP monies were tax-free and had not considered that the expenses paid with the loan proceeds would NOT be deductible.
An Example of the Good Deal
ABC Inc., a small-business S corporation with one employee (Bob), receives a $100,000 PPP loan, spends it all on defined payroll to the employee, and the lender forgives the full $100,000.
Fast forward to the 2020 tax return: ABC reports no PPP money as income (remember, it was tax-free income), but it may NOT deduct the $100,000 of payroll expenses as it normally would. The non-deduction effectively creates $100,000 of net taxable income that ABC, the S corporation, passes on to its sole shareholder, the employee Bob.
Let’s say Bob is personally in the 45 percent tax bracket when you consider both his federal and state income taxes. Bob must pay taxes of $45,000 on the income on his personal tax returns.
And let’s say that ABC passes to Bob the $100,000 of tax-exempt income. This puts Bob ahead by $55,000 ($100,000 - $45,000).
A good deal for Bob? — Yes, sure, of course!
But with the passage of the CARES Act, Congress was not trying to make a good deal —it was trying to provide ABC with the money for it to remain afloat and continue paying its employees during the COVID-19 pandemic. Otherwise, ABC would probably fold and Bob, an integral part of the small-business backbone of our economy, would be done.
So, what if it was like we all thought it was supposed to be… fully tax-exempt?
If the payroll expense in the above example were also deductible as an expense, ABC would be ahead by both the $100,000 and the tax benefit of the payroll expense deduction — giving the company a much better chance of continuing to pay its employee(s) after the PPP loan and its forgiveness and staying afloat much longer.
Since the S corporation doesn’t pay income taxes, let’s look at Bob again. He would have the $100,000 plus the tax benefit of the payroll deduction ($45,000) on his personal tax return.
Here’s the comparison:
$145,000 if the PPP would be as we thought it was (as intended by lawmakers on both sides of the aisle).
$55,000 as the IRS has it now according to Notice 2020-32.
That is no small difference.
Unfair?: Schedule C Taxpayer Suffers No Tax Bite
To add one more reason to why the business expenses paid from PPP loan forgiveness monies should probably be tax-deductible, consider this: The self-employed taxpayer with no employees has his or her loan forgiven based on his or her 2019 net income.
There’s no payroll to spend the PPP money on for a Schedule C self-employed taxpayer. And, the self-employed person does not have to spend any PPP monies on interest, rent, or utilities either. He or she can achieve full forgiveness in 10.8 weeks based solely on the 2019 tax return.
In the “You can’t deduct that!” notice (aka IRS Notice 2020-32), the IRS invokes IRC Section 265, but Section 265 does not consider how the PPP treats forgiveness for the self-employed. It applies to expenses incurred for the purpose of earning or otherwise producing tax-exempt income.
For the Schedule C taxpayer, no such expenses to produce tax-exempt income need to be paid to achieve 100 percent forgiveness.
Lawmakers Are Upset with the IRS
Let’s start with the fact that the IRS has a tough job. In many cases, the IRS is nothing more than a referee. If lawmakers fumble the tax law, the IRS has to call it. No choice.
In a letter to Secretary of the Treasury Mnuchin, Senator Chuck Grassley, chairman of the committee on finance; Senator Ron Wyden, ranking member on the committee on finance; and 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.
But, the IRS has held firm. That puts the ball back into lawmakers’ hands, and now it’s their turn to address what was previously overlooked or misunderstood.
This is where you come in, dear small-business owner…
Give Them a Nudge
Congress is working on additional COVID-19 legislation. And we suspect that you will see the new legislation enacted into law before Congress recesses for its summer break on August 8, 2020 (watch the news). That means things are moving quickly, and if you want your voice to be heard, you need to speak now.
To help create the action you desire, do this:
S. 3612 is the Senate bill to make the PPP forgiveness money used to pay business expenses tax-deductible. To express your yea or nay on S. 3612, contact your senators. 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. To express your yea or nay on H.R. 6821, contact your representative. 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 and do it quickly.
