IRS Released Guidance Re: Taxable Impact of the PPP Loan
November 26, 2020
Written by: Jessica M. Dorsett, CPA
On November 18, 2020, the IRS finally released the long-awaited guidance regarding the taxable impact of the PPP loans. Revenue Ruling 2020-27 is far from complete, but we can finally do tax planning with some certainty.
As a refresher, the CARES Act specified that the forgiven portion would be exempt from tax. However, the IRS was quick to remind us that expenses related to tax exempt income are not deductible, which results in a net increase to taxable income. In other words, it’s taxable. To date, Congress has not been able to remedy this apparent oversight in the draft of the Act. So, unless Congress is able to “fix” this, we will move forward with the current law of this loan resulting in a taxable event.
The new guidance addressed the timing question, partially. For calendar year taxpayers, the rules are clear. Since the covered period must end by December 31, 2020, the taxpayer will know the amount of eligible expenses that qualify for forgiveness and would have reasonable expectation of forgiveness. The ruling specifically states that timing of the forgiveness application is irrelevant. Therefore, you cannot hold the application until 2021 to defer the tax impact.
The timing issue was not addressed for fiscal year-end taxpayers. For example, a June 30 year-end corporation, which received its loan in May, likely has eligible expenses in May and June. It’s reasonable to expect that the loan may not have been fully used by 6/30/20. Therefore, should the corporation calculate and disallow the related expenses on the 2019 return, or does it wait until the 2020 return (year end 6/30/21)? Maybe the taxpayer is a 9/30 year-end and already used all the loan proceeds on eligible expenses. One could conclude from this ruling that those expenses should not be deducted.
The confusion is exacerbated, in my opinion, by Rev. Proc. 2020-51 which addresses a safe harbor for deducting expenses if the loan is not forgiven (in part, or in whole). This revenue procedure specifies taking the deduction on the 2020 return (taxable year beginning in 2020) or 2021 return. Therefore, it would appear the IRS expects these issues to be addressed on a 2020 or 2021 return, but not a 2019 return. It doesn’t seem consistent to me, and maybe we’ll receive some additional guidance, but in the meantime, we move forward.
The final thought for consideration is regarding the Company’s financial statements. If financial statements are prepared in accordance with generally accepted accounting principles (GAAP), we’ve been provided with 2 options:
- Report as a loan as of year-end, until forgiveness is approved, or
- Take the expected loan forgiveness into income if the eligible expenses have been incurred and there is reasonable expectation of forgiveness.
Generally speaking, tax reporting follows book reporting. If the Company chooses to defer reporting income on the financial statements, but reports “income” for tax purposes (as required), then there will be a book-tax difference for at least 2 years. A good reason for considering this reporting variance is due to loan covenants or for managing profit expectations. If the company is meeting loan covenants in 2020 without reporting loan forgiveness income, but management is concerned about declining revenues or other conditions in 2021 that may negatively impact loan covenants, there is a good reason for carrying the liability at 12-31-20. Then, in 2021, when the debt forgiveness income is picked up without expenses, the entire amount drops to net income. If there is concern about meeting covenants in 2021, this deferral of debt discharge income may help with covenants. I highly encourage you to discuss the strategy with your banker before making the final decision.
The PPP loan is only one area for consideration with tax planning this year. 2020 has been a unique year, to say the least. I presented on tax planning considerations in September, a recording of which can be found here. Other than the update to the PPP loan as discussed in this article, the rest of the considerations are current. We will be sending out a more comprehensive tax planning article after the Thanksgiving holiday.
Please reach out to our office if you have any questions or would like to start on your tax planning. The year is quickly coming to a close.
If you have not yet applied for the PPP loan forgiveness, and would like assistance, please complete the interest form on our website. We have assisted many clients through this process, many of whom have already received final SBA approval without challenge.