As a follow-up to our PPP Loan Forgiveness: Calculator and FAQs post, below is more information on a tax pitfall small businesses who received the PPP may encounter.
A recent IRS Notice will have the effect of a tax on small businesses that have their PPP loan forgiven. The CARES Act itself states that a forgiven PPP loan will not be considered taxable income to the small business. In essence, when you are forgiven debt by a bank or other party, the lender will typically issue the borrower a 1099-C for the amount forgiven, and the business or its owner will end up having to include that 1099 on their tax return and will have to pay tax on the amount forgiven as if it was income. Congress didn’t want this outcome, and as a result the CARES Act clearly states that forgiven loan amounts will not be considered forgiveness of debt income.
Despite this provision in the CARES Act itself, the IRS issued Notice 2020-32 and stated that while the forgiven loan is not income, the business cannot expense the use of those funds if the funds are later forgiven because of tax rules already in existence regarding loan forgiveness and business expenses. The net effect of this is that small businesses will be taxed on their PPP loan forgiveness, as they will not be able to write off those expenses (payroll costs, rent, mortgage interest, utilities).
This issue is still developing and is one that has been a surprise for small-business owners and their accountants and lawyers. There are already bipartisan bills pending in Congress to overrule the IRS interpretation, and leading lawmakers on the Senate Finance Committee — including Sen. Grassley (R) of Iowa and Sen. Wyden (D) of Oregon — as well as House Ways and Means Committee Chairman, Rep. Neal (D) of Massachusetts, have been working with the IRS to try to correct the guidance so that a bill would become unnecessary.
It’s unclear how this will play out, but there appears to be clear bipartisan support to overturn the IRS Notice so that small businesses are not taxed on their PPP loan amounts.
The PPP forgiveness rules will be the critical issues on the minds of small-business owners as PPP loans are being funded and put to work. Owners need to stay on top of the rules and guidance from the SBA and Treasury, and we all hope to see the SBA pivot more towards forgiveness rule issues and guidance as the second round of PPP funding is winding down.