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Following up on our blog Paycheck Protection Program (PPP) Loan Forgiveness – November 2020 Update, there is one more point to make: tax implications. As I noted many times on this blog over the past few months, while the loan will not be considered income, the IRS has ruled that forgiven expenses cannot be considered deductible expenses. Let’s dive into the Paycheck Protection Program loan forgiveness tax implications as you prepare to apply for forgiveness.

Hope Remains

When the IRS made their ruling in April 2020, there were many voices that said this needed to change. Legislators and business groups expressed that the impact of taxation on forgiven expenses would be a drag and counter to the intent of this program.

Reality Check

Unfortunately, no subsequent legislation in the summer reversed the IRS position. Add to that a lame duck Congress who has been frozen due to the election that carries on (thank-you Georgia). As it stands, it appears unlikely that the IRS position will change in 2020.

Scenarios If Forgiven Expenses Are Not Tax Deductible

Let’s look at the implications of losing the tax deductibility of the forgiven expenses with a few scenarios:

  • Operating with Big Losses
  • Operating with Moderate Losses
  • Profitable Operations

Operating with Big Losses

Should a business be operating with big losses, the lack of tax deductibility of those expenses would be null. For example:

  • Annual loss is $200,000
  • Forgiven expenses equal $100,000
  • The adjusted profit position for the business would be $100,000 – $200,000 or a loss of $100,000
  • No taxes due, but the loss is smaller

Operating with Moderate Losses

Should a business be operating at a moderate loss, the lack of tax deductibility of those expenses could put the business in a profitable position requiring tax payments. For example:

  • Annual loss is $20,000
  • Forgiven expenses equal $100,000
  • Federal tax rate of 22% (this can vary on individual income and business type)
  • The adjusted profit position for the business would be $100,000 – $20,000 or $80,000
  • Taxes owe would be roughly $17,600

This is very simplified (not a progressive calculation, tax rate varies widely by circumstance), but illustrative of the implications of this IRS ruling.

Profitable Operations

Should a business be operating profitably, the lack of tax deductibility could increase tax exposure. For example:

  • Annual profit of $50,000
  • Forgiven expenses equal $100,000
  • Federal tax rate of 22% (this can vary on individual income and business type)
  • The adjusted profit position for the business would be $100,000 + $50,000 or $150,000
  • This could increase the tax rate to the next bracket 24%
  • Tax burden would go from roughly $11,000 to $36,000

Again, this is a very simplified calculation (not a progressive calculation, tax rate varies widely by circumstance), but illustrative of the implications of this IRS ruling.

Application Timing

Many financial professionals are recommending that businesses wait to file their forgiveness applications. If the loans aren’t forgiven in 2020, expenses should still be deductible – in theory. Should a business apply today, it’s probably not a big issue as lenders have 60 days to review loans before submitting to the SBA who has 90 day to rule whether the loan is forgiven.

The safe bet is to hold off on applying until 2021. A reasonable bet is forgiveness is not provided in 2020 even if you apply today.

What we need to see is if the IRS ruling be overturned before the forgiveness window is over. As a reminder, that window is 10 months after the completion of your coverage period.

Our Recommendation

Businesses have 10 months to apply for forgiveness. Payments are deferred during that 10 months period. Time is still on our side.

Preparing the loan forgiveness now is not a bad idea if you are anxious. Waiting to submit in 2021 is probably the best bet. That said, submitting now probably won’t affect you as receiving forgiveness from the SBA is unlikely.