As you know, under the provision of the PPP regulations, if you use the funds properly, all or a portion of the loan will be forgiven. What normally happens when a debt is forgiven, the forgiven amount is considered income. It isn’t something you earned but it is money that came in the door that you didn’t have to return. Since the only real option for that kind of windfall is a gift or income, and since lenders don’t give gifts, by default it would be a form of income. Here’s what would happen under normal tax laws:
You receive a loan of $50K which is forgiven. That becomes $50K of income. You spent the $50K all on wages. The $50K of wages becomes a tax deduction. Simple math shows income of $50K less expenses of $50K for a net income of $0.
But PPP loans are not typical and the law states that amounts forgiven are excluded from gross income.
On Friday, the IRS released guidance stating that if you use PPP funds on qualified expenses resulting in PPP loan forgiveness, then you cannot take those expenses as tax deductions. Now, the IRS didn’t state the forgiven amount would be included in income as is normally the case, which seems in line with the intent of CARES. But they said you can’t take the deductions. So let’s walk this through.
You receive PPP funds of $50K, use them properly and they are forgiven. You do not have to recognize income according to the CARES Act. You spent the $50K all on wages. The $50K of wages becomes a tax deduction. IRS guidance released Friday says you can’t take the deductions that were paid by forgiven funds. So the $50K of wages deduction is reversed. Here’s the new calculation:
Hmmm, this result looks awfully similar to the normal tax law results, as if we had just taken the forgiveness as income. So the IRS is being challenged. The CARES Act went to the trouble of excluding the forgiveness from income. According to our sources at the ADA who are continually in contact with Washington lawmakers, both democrats and republicans in the House and the Senate believe the IRS got this wrong. There is much optimism that the IRS position will be reversed.
Here’s what we believe the PPP provisions of the CARES Act intended. Again, the law states that any PPP amounts forgiven are excluded from gross income. So the scenario above, instead of a net $0 effect, becomes a $50K tax deduction.
Big difference! A change in IRS position is far from reality but there’s a possibility this will move to a better tax position.