*** UPDATE*** The Consolidated Appropriations Act of 2021 wassigned into law on December 27, 2020, brought with it significant extensions and expansions to tax law including updates to the Employee Retention Credit (ERC) provisions.
Many organizations have applied for loans through the Small Business Administration (SBA) Paycheck Protection Program (PPP) program due to liquidity concerns stemming from COVID-19. These loans were created under the CARES Act to assist employers in maintaining their employee head count during the COVID-19 crisis. Many organizations have had their loans funded or are applying for the loans.
PPP Loans may be 100% forgivable if the funds are used predominately on payroll costs and other costs, such as; mortgage obligations, lease agreements, or utilities. In addition there are requirements that employee head count stays consistent to pre-COVID-19 levels. The details of such calculations are outside the scope of this article; however, the calculation’s inputs and ultimate debt forgiveness will impact an organization’s tax reporting.
It was clear from the CARES Act that the amount of debt forgiveness received would be excludable from federal taxable income; however, there was some ambiguity surrounding whether such expenses that the debt forgiveness amount is calculated upon would be deductible or non-deductible for federal income tax purposes.
The IRS gave us clarity on April 30, 2020 that those expenses will be treated as non-deductible expenses up to aggregate amount debt forgiveness. The IRS released Notice 2020-32 that states the debt forgiveness creates a class of exempt income under IRC Section 1.265-1(b)(1), and therefore the code disallows any otherwise allowable deductions under any provision of the code related to that class.
This position correlates with previous IRS attempts to prevent “double-dipping”; getting debt forgiveness and deducting all the expenses for which the forgiven amount was based or used to fund. Some leaders in Congress have expressed concern over this position, as they believe it was not the intent of Congress to disallow the deduction of such expenses. However, this can only be changed through additional legislative action or court challenges.
As always, every situation is unique. Please do not hesitate to contact us with any questions.
Stay safe and healthy!