The Paycheck Protection Program (PPP) brought relief to small businesses when they needed it the most, but left borrowers with many unanswered questions around how this relief will affect their 2020 tax obligations.
Like many of the questions raised in 2020, the answer is unclear. Here is what we know so far, what answers we are still waiting for, and recommendations from Grassi’s tax advisors to help PPP borrowers navigate this most unique year-end and upcoming tax filing season.
Timing of PPP Loan Forgiveness
At this point in the year, it is clear that loan forgiveness is going to be a 2021 activity. Based on the SBA Procedural Notice Control N0.: 5000-20038, a Paycheck Protection Loan (PPL) is forgiven when the SBA reimburses the bank originating the loan for the forgiven principal and interest. The entire application and SBA forgiveness review process can take up to 150 days.
With funds being received in 2020 and forgiveness taking place in 2021, where does this leave borrowers in their year-end reporting and tax planning?
Deductibility of PPL-funded expenses
The IRS’s current position is that expenses funded with forgiven PPL funds are not deductible. This means that on income tax returns for the 2020 calendar-year (or fiscal year ended in 2020), expenses paid for with forgiven PPL funds cannot be deducted.
The IRS ruled in Notice 2020-32 that the payment of allowed expenses funded by forgiven PPL funds are not tax-deductible because it would create a “double tax benefit.” One of the authors of this notice, Sarah Daya, further explained the IRS’s position on when these non-deductible expenses should hit the tax return:
- If in 2020, there was certainty that a borrower’s PPL would be forgiven, the 2020 expenses funded with the forgiven loan funds should be reduced. (How this should be done was not explained.)
- If the loan was subsequently not, or partially, forgiven, an amended 2020 return would need to be filed to claim these deductions.
- If 2020 expenses funded with PPP loan proceeds were deducted on a 2020 return, the loan was forgiven in 2021, and the loan forgiveness was reported as income on a 2021 return, the IRS would require an amended 2020 return be filed reducing 2020 expenses, and interest and penalties would be charge on the balance.
Ms. Daya’s explanation is clearly based on the assumption that loans will be forgiven no later than December 31, 2021, and that loan forgiveness is a 2020 tax reporting transaction.
Many legislators, advocacy groups and associations have called for this deduction limitation to be reversed, claiming that it imposes undue hardships on the very businesses the PPP was intended to assist. Both Representatives and Senators have promised to make this happen. However, no such legislation has passed, and there are few remaining opportunities to pass it in 2020. Those opportunities are another stimulus bill; the continuing resolution to fund the federal government (which must pass by December 11); and the year-end tax extender legislation. The AICPA legislative affairs division believes that tax deductibility legislation will pass in 2021.
Adding to the uncertainty this year is the fact that the IRS has yet to issue guidance on how PPL-funded non-deductible expenses affect simultaneous calculations such as 163(j), 199A, 263A, R&D and WOTC credits, 460, and pension-profit sharing plan contributions.
Applying for PPP Loan Forgiveness
The uncertainty surrounding the tax deductibility issue should not discourage PPP borrowers from moving forward with their loan forgiveness applications. The timing, preparation and submission of the application will not affect the tax deductibility or non-deductibility of PPL-funded expenses.
However, there are other income tax issues to keep in mind when preparing your corporate 2020 income tax return:
- To the extent a PPL is not forgiven, these expenses are deductible on a 2020 income tax return.
- PPL funds are not taxable income. How receipt of these funds will be reported, if at all, on an income tax return, has not been determined.
2020 Estimated Income Tax Payments
Recommendations for Pass-Through Entity Owners in NY
To the extent a pass-through entity owner’s 2020 adjusted gross income (AGI) is greater than or equal to their 2019 AGI, their 2020 federal and New York estimated taxes should be based on 110% of their respective 2019 federal and New York total taxes after credits (i.e.: safe-harbor payments). For other states in which the owner pays taxes, each state’s safe-harbor amount will need to be determined.
To the extent a pass-through entity owner’s 2020 adjusted gross income (AGI) is less than their 2019 AGI, their 2020 federal and New York estimated taxes CAN be based on 110% of their respective 2019 federal and New York total taxes AFTER credits (i.e.: safe-harbor payments), or calculated based on their estimated 2020 income. This calculation will be based discussions with a client about the deductibility of PPL funded expense. For other states in which the owner pays taxes, each state’s fourth quarter payment will need to be calculated.
Recommendations for C Corporations
Based on our observations about the deductibility of PPL-funded expenses, a C corporation’s 4th quarter estimated tax payment will have to be calculated and paid according to the calculated amounts.
If a C corporation calculates and pays its 4th quarter federal estimated tax payment based on the non-deductibility rule, the PPL expenses become deductible, which would result in an overpayment of 2020 federal estimated tax payments. If eligible, the C corporation may file Form 4466 to get a quick refund of the overpayment.
Recommendations for 2020 NYC and NYS Estimated Tax Payments
Based on our observations about the deductibility of PPL-funded expenses, a corporation’s 4th quarter estimated tax payment will have to be calculated and paid according to the calculated amounts.
Recommendations for Filing Calendar Year 2020 Income Tax Returns
Due to the uncertainty about the deductibility of PPL fund expenses and how these affect simultaneous income tax calculations, calendar year flow-through entity taxpayers with returns due on March 15, and calendar year C corporation with returns due April 15 should refrain from filing their respective returns by these dates and file for extensions.
If returns are filed following the IRS’s position, and the PPL expenses are eventually deemed deductible, an amended return would need to be filed to claim the expenses. Consequently, the taxpayer would incur additional fees and have to wait for a refund.
Recommendations for Filing FYE 2020 Income Tax Returns
Due to the uncertainty about the deductibility of PPL fund expenses and how these affect simultaneous income tax calculations, FYE 2020 taxpayers should refrain from filing their respective returns by original due date. These returns should be extended.
The IRS has not commented on how non-deductible expenses should be treated on FYE 2020 returns. If an organization has already filed its FYE 2020 return and deducted PPL-funded expenses, we highly recommending consulting with your tax advisor about the IRS’s position, the consequences, and delaying loan forgiveness until the expense deductibility issue is resolved.
Loan Forgiveness after SBA Audit
It is unclear whether loan forgiveness could be rescinded after an SBA audit. If the IRS’s non-deductibility position prevails, presuming the SBA will conclude any loan audits before the statute of limitation on 2020 returns filed in 2021 expires in 2024, any expenses which become deductible due to forgiveness would be claimed on an amended 2020 return.
Tax-Exempt Entities and Loan Forgiveness
Unless the entity has unrelated business taxable income and files Form-990-T, the income tax deductibility of PPL funded expenses is of no consequence.