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No Tax Deduction for Expenses Paid with Forgiven PPP Funds
Revenue Procedure 2020-51 permits taxpayers to claim deductions for amounts paid using PPP loan
proceeds in certain circumstances where part or all of such PPP loan is not forgiven.
New Guidelines Provided
Notice 2020-32 outlines the IRS's position that, based on existing tax law intended to prevent such a double benefit, otherwise deductible business expenses paid with forgiven PPP funds will be disallowed as tax deductions in computing the recipient's taxable income. The nondeductible treatment applies for any payment of eligible PPP expenses to the extent of the loan forgiveness.
Business with partial loan forgiveness: If a business only has partial forgiveness of its loan, it may still have deductible expenditures attributable to the unforgiven portion.
Business with entire loan forgiveness: The net result for a business with its entire PPP loan forgiven should be tax-neutral for federal tax purposes. The forgiveness is not taxable, and the expenses paid with the forgiven funds are not deductible.
Palma Financial Observation: In the case of partial forgiveness, and thus partial deductibility, it will be important for taxpayers to identify what specific expenses were paid with forgiven funds vs. funds that will be repaid. This distinction may have other tax implications.
For example, otherwise deductible interest expense may be limited by Internal Revenue Code (IRC) section 163(j), and deductible salary expense may be needed to support a section 199A deduction.
Palma Financial Observation: The CARES Act modified the rules for Net Operating Losses (NOLs) arising in 2018, 2019, and 2020 to allow taxpayers to carry those NOLs back five years to offset prior taxable income.
Alternatively, those NOLs may now be carried forward without being subject to the 80 percent taxable income limitation. With the disallowance of expenses paid by forgiven PPP funds, taxpayers may now have less of an NOL to carryback/forward than they may have been initially projecting. Even without an NOL, taxpayers should adjust their projected taxable income/loss calculations to account for the fact that they may now have significantly fewer deductible expenses than initially expected.
Palma Observation: Some Congress members have expressed that they intended to have tax-free forgiveness and deductibility of the business expenses. Such a result will most likely need to be achieved through legislative action. A future economic response bill may attempt to ensure deductibility of expenses paid with forgiven PPP funds.
State and Local Implication: The tax impact of PPP loan forgiveness and deductibility of qualified expenses at the state level will depend on each state's determination. Even states with rolling conformity to the Internal Revenue Code (IRC) may need to determine whether or not they will tax the forgiveness since the CARES Act did not amend the IRC when providing the tax exemption for forgiveness.
For California specifically, the forgiven debt is currently considered taxable income. Therefore the expenses paid with forgiven funds should generally be tax-deductible, with a tax-neutral result. However, California has indicated that it will be providing additional information on its tax treatment of CARES Act items as it completes its analysis of the CARES Act.
Palma Financial Services, Inc. has been actively monitoring these issues. Book your PPP Tax Assessment if you have any questions about this or any other COVID-19-related items
If you're ready to take the guesswork out of your taxes and save money along the way, then our tax planning services are what you need. We are a CPA firm specializing in tax planning and CFO services. And we will also prepare your income taxes and take care of your financial planning.
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Miguel A Palma CPA, PFS, CGMA
Founder of Palma Financial Services, Inc.
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