ALERT – Tax Gift for 2020 PPP Borrowers
Good to Know
In the cosmic order of U.S. tax law, expenses associated with tax-free income are frequently not deductible. In the case of Payroll Protection Program loans, the IRS went one step further to rule that expenses paid with the proceeds of PPP loan debt were not deductible if the loan was merely expected to be forgiven. Happily for business owners with forgiven PPP loans, the COVID-Related Tax Relief Act of 2020 emphatically reversed the normal cosmic order of taxation. This legislative saga began with the CARES Act.
CARES Act
The CARES Act of March 2020 allowed the forgiveness of PPP loans for borrowers that used loan proceeds for qualified expenses and met other requirements. Qualified expenses included payroll-related costs and a specified list of other ordinary, reasonable, and necessary business expenses.
Generally, when a loan is voluntarily forgiven, the amount of forgiven debt is included in the borrower’s total gross income. Contrary to that IRS doctrine, the CARES Act provided that forgiven PPP loans were excluded from the borrower’s total gross income. As financial advisors, planners, and tax professionals analyzed the legislation, it quickly became apparent that the deductibility of expenses paid with forgiven PPP loan funds was not addressed.
IRS Interpretation of the CARES Act
Nature and the IRS abhor a vacuum and, as you might predict, the IRS subsequently determined that expenses paid with funds from forgiven PPP loans were not deductible. According to IRS Revenue Ruling 2020-27, “… no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of a [PPP] covered loan.”
Eligible expenses at the time the CARES Act became law included:
- Payroll costs,
- Certain mortgage interest payments,
- Certain rent payments, and
- Certain utility payments.
While few businesses would look a gift horse in the mouth by complaining about PPP loan forgiveness, being able to deduct expenses paid with forgiven PPP loan funds could be a tax windfall for businesses that somehow remained profitable in 2020.
COVID-Related Relief Act of 2020
This Act included a smorgasbord of mostly favorable tax and other provisions. Specifically applicable to the topic of this blog, the Act made clear that no otherwise tax-deductible expense is to be denied as a result of the exclusion of forgiven PPP loans from total gross income.
Although not completely unprecedented, it’s a rare and most welcome tax event when a business can borrow money, have the loan forgiven, exclude the forgiven debt from total gross income and then deduct any qualified expenses paid with the borrowed funds.
Be sure to contact your tax professional to determine if or how this tax relief could benefit your clients.
Disclaimer
The information presented herein is provided purely for educational purposes and to raise awareness of these issues; it is not meant to provide and should not be used to provide legal, compliance or financial advice. There are variations, alternatives, and exceptions to this material that could not be covered within the scope of this blog.
