IRS Decides PPP Loan Expenses are Not Deductible – Is the PPP Loan Still A Good Idea?

Colorado sales tax compliance

In a ruling that came as a surprise to many, the IRS published a notice yesterday that declared expenses paid that are used to calculate the forgiveness portion of the Payroll Protection Program loan are not-deductible.

This throws a wrench in the earlier thinking that these loans would not be taxable. The Cares Act specifically stated that the forgiveness of these loans would not be taxable. For anyone contemplating a PPP loan, this could be great deal for the business. Free money that could be 100% forgiven if it was spent correctly. What a great thing to keep a business afloat, right?

Wrong says the IRS. While the IRS position technically agrees with The Cares Act in that the act of forgiveness does not result in taxable income, the IRS pointed to code sections and case law which rules that deductions as the result of tax-free income are not deductible. In other words, the loan forgiveness is tax-free but you can’t deduct the expenses used to calculate the forgiveness. In other words, the forgiveness of the loan will feel like taxable income.

In many cases, the business owner will still be ahead of the game even if the expenses are not deductible. For example, let’s say a business received a $50,000 PPP loan, spent it on normal payroll costs, rent and utilities per the forgivenesss guidelines, and had the entire loan forgiven. They used the $50,000 to keep the business operating and cash flowing. They are $50,000 ahead from a cash-flow standpoint, but will owe taxes on that $50,000. In a typical tax bracket, that could cost about $13,000 in taxes. They are ahead a net of $37,000.

But what about the business owner who spent the $50,000 on retaining his or her employees by paying them for the 8-week forgiveness period instead of letting them collect unemployment? Let’s say this business owner really didn’t have work for them to do but wanted to keep the staff employed with a regular paycheck. Perhaps revenue ran dry, but the owner was watching out for his or her staff by making sure they got paid. If the PPP loan was not available, the business owner would have certainly laid of the employees and they would have collected unemployment. With the PPP loan, the owner has the cash to pay the employees, but those expenses are no longer deductible. In this case the owner will have the same tax liability by using the PPP loan proceeds to pay staff versus laying off the staff and not taking the PPP loan. But don’t forget, the business owner is still responsible for the employer side of Fica/Medicare at 7.65% of the employees’ wages since that part is not eligible for expenses relating to the loan forgiveness. For that portion, the business is paying out-of-pocket sinceĀ 

Where the owner can benefit is by paying staff to streamline operations, documenting procedures and generally improving operations for when the business re-opens.

Does it all make good business sense? Maybe. Maybe not. It might be worth a look to see if you should keep those funds or if you should use it in the way you thought you might before this rule change.

Before this latest IRS ruling, most of us thought the business would not only get a nontaxable source of cash, but also benefit from the tax break. We do believe this is what Congress intended but, until Congress corrects the law, the IRS has ruled the expenses are not-deductible.

Unfortunately this is what we have been dealing with. A lot of uncertainty, many rule changes, and having rules changed after-the-fact.