The Paycheck Protection Program has been a hot topic for the last few weeks, with restaurants and other small businesses everywhere scrambling to get their slice of over $650 billion in SBA loans. Providing these loan proceeds are used for approved purposes such as payroll costs, employee healthcare benefits, rent, utilities and interest on existing debt obligations, the loans are eligible to be forgiven in full and free of income tax on the forgiven proceeds.
Among many other questions from loan recipients and their tax advisors was the deductibility of expenses paid for with loans that would eventually be forgiven. Surely the IRS would not allow a deduction for expenses paid with loan funds that were never required to be repaid and never included in gross income, would they? The answer seemed obvious, as “double-dipping” in this manner is rarely allowed, but still no official guidance had been issued.
This week our official guidance arrived in the form of Notice 2020-32, and as most tax professionals probably suspected, expenses paid with forgiven loan proceeds will not be deductible on the tax returns of PPP recipients. The technical reasoning for the decision is that the forgiven loan proceeds will be considered a class of exempt income, which is any form of income that is either excludible from gross income or exempt from taxes under IRS regulations. Internal Revenue Code Section 265 addresses the tax treatment of expenses paid for the purpose of earning or otherwise producing tax-exempt income – and no surprise here, expenses related to the production of tax-exempt income are not deductible.
This will create further challenges for tax professionals in the upcoming 2020 filing season, as CPAs will need to work closely with their clients to make sure that PPP loan proceeds are not incorrectly being included in gross income, while also making sure that any related expenses that were paid with forgiven funds are not incorrectly deducted. The other side of that coin will be making sure that for clients with PPP loans that are either not forgiven or only partially forgiven, expenses paid with non-forgiven funds are rightfully deducted on their returns.
So what does this mean for your restaurant? If you received PPP loan proceeds, it is critical that you track the inflow and outflows of those proceeds with the utmost care and detail, for a variety of reasons. Most importantly, when it comes time to have your loan forgiven, you want to be able to prove without a shadow of a doubt that the proceeds were used for eligible costs, and that your loan meets the requirements for forgiveness. On top of this, you want to be sure that everything involving your PPP loan stands out like a sore thumb for your CPA. This will help ensure that all reporting is done correctly, and that you don’t pay too much tax or run into trouble with the IRS or SBA down the road.
Austin Bradley, CPA