Regulatory and Tax Updates
Taxation of Forgiveness of Paycheck Protection Program Loans
This article was originally published on April 22, 2020. It was updated on July 10 to reflect the latest information from the IRS on taxation of Paycheck Protection Program Loans.
- As many businesses begin to receive Paycheck Protection Program loan disbursements, questions are soon following.
- Here's what we know about how these loan funds will be taxed.
- We'll continue to share additional information as guidance is released.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act became law on Friday, March 27, 2020. The CARES Act included a new federally guaranteed Small Business Administration (SBA) loan program called the Paycheck Protection Program (PPP). The maximum PPP loan was based upon two and one-half months’ average payroll costs for the prior 12 months. If the business pays qualifying costs over the eight-week period or 24-week Covered Period beginning with the funding of the loan, the entire debt may be forgiven. Usually, the forgiveness of debt generates taxable income for the borrower. After the IRS released additional guidance, it appears that may not be the case with PPP loan forgiveness.
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The PPP is designed as a federally guaranteed loan program that becomes a federal grant to the extent of the debt forgiveness. Businesses need to understand the taxation of the forgiveness of debt.
PPP loan forgiveness is granted based upon paying qualifying costs during the eight-week period week or 24-week Covered Period beginning with the initial funding of the loan. The sum of the following enter into the forgiveness computation: payroll costs; health insurance for paid sick, medical, or family leave; mortgage interest payments; rent; and utility payments. The mortgage, rent agreements, and utility agreements must have been in place before February 15, 2020. For the sole proprietor and partner, 8/52nds of the 2019 self-employment income is considered the forgiven amount if the eight-week Covered Period is chosen. If the 24-week Covered Period is used, the forgiven amount associated with the proprietor’s earnings is 2.5 divided by 12 of the 2019 self-employment income. These limits also apply to the wages of employee-owners of an S or C corporation.
The SBA interim final rules stated that at least 75% of the forgiveness amount must relate to payroll costs. Congress lowered the threshold to 60% of payroll costs upon enactment of the PPP Flexibility Act. Payroll costs should include compensation, health insurance, retirement pay, and state and local payroll taxes.
In addition to the foregoing limitations pertaining to expenses, the PPP reduces the loan forgiveness amount unless the business satisfies two tests: employee count and employee wages.
Taxation of PPP loan forgiveness
The CARES Act provides that the debt discharge of a PPP loan is excluded from the gross income of the business for federal income tax purposes. Forgiveness is limited, based upon the payment of qualifying expenses and the maintenance of employee count and compensation. Businesses shouldn’t assume full exclusion from taxable income, however.
On April 30, 2020, the IRS issued Notice 2020-32, which provides that borrowers cannot deduct otherwise deductible expenses that they paid using funds from a PPP loan that was subsequently forgiven. In effect, the IRS eliminated the tax benefit of PPP loan forgiveness. Several bills have been submitted in Congress to overturn the effect of the IRS notice. In addition, the American Institute of CPAs (AICPA) is on record supporting legislation to allow deductions for the qualifying costs.
How we can help
CLA’s team continues to keep a pulse on the CARES Act and related guidance, including the documentation you must provide to help your organization qualify for PPP loan forgiveness. CLA professionals are available to help you navigate these uncertain times.
Chris Hesse is the chair of the AICPA Tax Executive Committee.