PPP Borrowers Cannot Deduct Expenses Paid With Forgiven PPP Loan Proceeds
On May 1, the IRS released guidance addressing the deductibility of the expenses paid by businesses receiving a Paycheck Protection Program (PPP) loan. While the CARES Act provides that PPP loans are fully or partially forgivable, it does not otherwise address whether deductions can be taken for expenses paid from forgiven PPP loan proceeds.
The IRS guidance addressed this question. According to the IRS, PPP borrowers cannot deduct expenses paid with forgiven PPP loan proceeds. Borrowers who used forgiven PPP proceeds to pay payroll, benefits, rent, utilities, and mortgage interest cannot take a deduction on their federal income tax for such payments.
The IRS guidance specifies that the amount of a PPP loan that is forgiven is excluded from a borrower’s gross income and is thus tax-exempt income under the CARES Act. Current IRS regulations provide that otherwise deductible expenses paid with tax-exempt income are generally not deductible.
What does this mean for my business?
First, it does not mean that your tax liability will go up. It simply means that you will not get the benefit of all of the free money (assuming it is all forgiven) that you originally thought. IT will “cost” you the percentage of the tax bracket you are in multiplied by the amount of your loan. In other words, it is just less free money that you will be receiving. Ultimately each forgiven dollar spent on an otherwise deductible cost will not be available to offset a borrower’s tax liability later.
PPP loan forgiveness is a complicated calculation that depends on how a business spends the amount of its loan and also takes into account employee headcount and overall employee compensation. Forgiveness is capped at the full amount of the loan and will be limited in the first instance to the amount of money spent on payroll (employee wages, salaries and benefits) and other qualified costs (interest on mortgages and other debts, rent, and utilities) during the 8-weeks following receipt of the loan proceeds. From there, forgiveness is proportionally decreased based on decreased employee headcount and compensation. And, the other qualified costs category is limited to comprising only 25% of the total loan forgiveness amount.
Each borrower is in a unique position and needs to consider a number of factors, including projected business plans and how it will spend the amount of money received as a PPP loan. With that said, PPP loans appear best suited for borrowers who will use as much as possible of the amount of money provided for payroll costs. Borrowers who anticipate maxing out their PPP loan use on mortgage interest, rent, or utilities may want to consider other COVID-19 related assistance.
To discuss PPP loans and other COVID-19 sources of assistance for your business, please contact an attorney at The Lynch Law Group.