As the end of what seems to be the longest year approaches, many business owners and their trusted advisors are now in the process of preparing the application for the forgiveness of the Paycheck Protection Program (PPP) loan that was granted to their business earlier this year. While many businesses may have already completed their applications, very few, if any, have been able to actually file it because many financial institutions have not yet opened their portals to allow for submission. On the surface this may not seem like a big issue, however, since the forgiveness determination is tied to expense deductibility, year-end tax planning, while always important, is a bit more critical this year as we must determine whether, and more importantly when business expenses will be deductible.
Our previous Alert (here) discusses the IRS guidance related to the deductibility of expenses paid for with PPP loan proceeds. The IRS, in Notice 2020-32, denied businesses the deduction for expenses paid with forgiven PPP loans stating that under IRC Section 265, expenses related to the production of tax-exempt income are not deductible. At the time the IRS issued its position back in April this did not seem to pose a problem as it was likely that the decision on forgiveness would occur in the same year that the expenses were paid. Essentially, there would be no impact on taxable income as the debt forgiveness is tax-exempt and the expenses are nondeductible.
However, the extension of the original 8-week period to use the PPP proceeds to a 24-week period creates a situation where businesses seeking forgiveness of their PPP loans have paid the expenses during 2020 but will not receive their forgiveness determination until 2021. Hence the quandary – are the expenses deductible in 2020 since there is no determination on forgiveness? Assuming that is an appropriate position to take, it would follow that there would be a disallowance of expenses in the year that forgiveness is determined.
It’s clear that the intention of the CARES Act was to help businesses through this crisis, even if that means deducting expenses paid for with “free money”. Further, there appears to be bipartisan support for a “fix” to this deductibility issue. What is unclear is whether we will have an answer to this question prior to year-end or even prior to the due date of the 2020 tax returns. This open issue of whether to deduct or not deduct expenses puts a complicated spin on the year-end tax planning process.
With only two options to consider, business owners should be working with their advisors to analyze the impact of deducting versus not deducting expenses on their projected tax liability. Regardless of the decision that gets made now, you would still have until the due date of your 2020 tax return (including extensions) to ultimately determine the deductibility of these expenses.
Please contact your WG Advisor if you’d like to discuss this, or any other questions you may have, further.