David S. McLaren is the managing partner of McLaren & Associates CPAs, LLC in Shrewsbury. Reach him at Dave@dmclarencpa.com.
Updated: December 7, 2020
know how
Watch out for these PPP tax surprises
By David S. McLaren
One of our government-provided assistance plans during the pandemic was the Paycheck Protection Program loan. The Small Business Administration, with the help of banks, gave out more than 5 million loans, making this program one of the most popular for small business. There was a great deal of confusion getting these loans and even more confusion later, as the rules and regulations changed.
One of the main points was the loans would be forgiven if you spent the money during an eight- or 24-week period. The requirements included spending 60% or more on payroll including benefits, 40% or less on utilities, loan interest and rent. Other parameters included maintaining or restoring the full-time equivalency of your employees as well as keeping their pay level the same or more, but not a pay cut of more than 25%.
Most small business owners were told in the news these loans were then forgiven, TAX FREE! How could you beat that?
Unfortunately, the Internal Revenue Service issued a notice, stating any expenses paid with money from a forgiven PPP loan cannot be deducted on a tax return. What does that mean?
That means even though the forgiveness of the money was tax free, you now could not deduct the expenses you paid for with that money.
To clarify, if you did not have a profit this year, and you were at zero, there would generally be no tax on your profit as you did not have any. If you received a $100,000 PPP loan, and it was forgiven because you spent the money as directed, you now will have a $100,000 profit to pay tax on, even though you do not have that money.
What’s worse, if the tax rate is 35%, you owe $35,000 on money that you no longer have. Normally, if you receive $100,000 and you have to pay $35,000 in taxes, you may not like it, but you pay your tax and still have $65,000 left in your hand. In our example above, you have no money left in your hand but still have to pay tax on the $100,000. Surprise (and not in a good way)!
Where will the money come from to pay the tax? Do I just repay the loan?
Certainly this will depend on your personal circumstances. I would certainly say paying the $35,000 in my example for the tax is better than paying all $100,000 back with interest. But what if you do not have the $35,000?
All is not lost
The government has had a fix for this in multiple bills, none of which has passed to date. If they fix this, then you will be able to deduct the expenses. If not, you need to have a tax projection to avoid surprises in April. Seek out your tax advisor as soon as possible to address this or give us a call.
Other options
The IRS issued a notice. This is not a law. There are options to challenge the IRS’s position on this notice. We recommend you speak to your tax advisor to address this option as well.
All of this was new for the IRS as well. Massachusetts does not appear to even have accepted the forgiveness being tax free as of the date this was written.
So while this may come as a major surprise to many, and even a kick in the gut to many suffering local businesses, there may be options to help your specific situation, whether challenging the IRS, making it a loan or even using losses to offset the taxability. Reach out to your tax advisor for help and planning now so this is not a surprise six months from now. Together, we will get through this.
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