Deductibility of Expenses Paid for with PPP Loans and Other Relief Provisions

January 12, 2021 - The “Consolidated Appropriations Act, 2021 (CAA, 2021)” signed into law December 27, 2020 provided a number of provisions designed to financially help out businesses affected by COVID-19.  CAA, 2021 did this by eliminating the potential tax burden from making expenses paid for with Paycheck Protection Program loans nondeductible, extending eligible loan subsidies, and replenishing the Economic Injury Disaster Loan Advances.

The Internal Revenue Code broadly defines gross income as “all income from whatever source derived.”  Generally, loan proceeds are not includible in gross income of a business so long as the loan is a bona fide debt and is required to be repaid.  If a loan is no longer required to be repaid, or was repaid by someone else, this could potentially be income to the taxpayer.  The Paycheck Protection Program (PPP) loans established by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) issued loans to eligible taxpayers and if the taxpayers pay qualified expenses a portion, or the entire loan would not be required to be repaid.

Congress knew that relief from an obligation to repay the PPP loans could create income to the borrower. With this in mind, Congress specifically put in a section of the CARES Act which provides that any amount that would be includible in gross income of the recipient of a PPP loan by reason of forgiveness “shall be excluded from gross income.” This provision excludes from a borrower’s gross income any of income that may arise from forgiveness of the PPP loan, regardless of whether the income would be properly characterized as income from the discharge of indebtedness or otherwise includible in gross income under any other code section. 

Normally ordinary and necessary business expenses, such as salaries and rent, are deductible in determining taxable income. The IRS agreed that the Congress specifically made the PPP loan forgiveness not income to the taxpayers.  However, the IRS took the position that expenses paid with PPP loan proceeds that would generally qualify as ordinary and necessary business expenses were nondeductible.

Notice 2020-32 stated the IRS position that deductions for expenses paid with PPP loan proceeds that result in forgiveness of a covered PPP loan are disallowed when the income associated with the forgiveness is excluded from gross income under the CARES Act because the payment of those expenses is allocable to tax-exempt income.  The IRS further cemented their position with Revenue Ruling 2020-27.

Members of Congress realized the unintended tax burden this could put on individuals and businesses that were already being hit hard by the Coronavirus restrictions and continuously criticized the IRS’s position on the non-deductibility of eligible expenses. Congress argued that the denial of deductions for business expenses paid with proceeds of a PPP loan that is later forgiven undermines the legislative intent of the PPP.

The Consolidated Appropriations Act, 2021 (the CAA, 2021), signed into law on December 27, 2020 addressed this issue and stated Congress’ original intent. CAA, 2021 retroactively amends the CARES Act to provide that no amount should be included in the gross income of a PPP participant by reason of forgiveness of a covered loan, and no deduction is denied, no tax attribute is reduced, and no basis increase is denied, by reason of the exclusion from gross income.

CAA, 2021 also clarifies that gross income does not include forgiveness of EIDL loans, emergency EIDL grants, and certain loan repayment assistance. The provision also clarifies that deductions are allowed for otherwise deductible expenses paid with the proceeds of these loans and that tax basis and other attributes will not be reduced as a result of those amounts being excluded from gross income.

The CARES Act included a provision that states the SBA to pay for a six-month period, the principal, interest, and any associated fees that small businesses owe on previous 7(a) loans, 504 loans, and microloans.  CAA, 2021 extended the period that the Small Business Administration will make these principal and interest payments on the on the recipient’s qualifying loans.

The CAA, 2021 also reinstates the EIDL Advance.  This will allow businesses suffering a substantial economic injury to apply for an advance that does not need to be repaid or up to $1,000 per employee limited to $10,000 total. 

In order to qualify for the full “Targeted EIDL Advance” of $10,000 a business must: 

  • Be located in a low-income community, and
  • Have suffered an economic loss greater than 30%, and
  • Employ not more than 300 employees

In addition, the business must qualify as an eligible entity as defined in the CARES Act:  

  • A small business, cooperative, ESOP Tribal concern, with fewer than 500 employees
  • An individual who operates under as a sole proprietorship, with or without employees, or as an independent contractor; or
  • A private non-profit or small agricultural cooperative.
  • The business must have been in operation by January 31, 2020
  • The business must be directly affected by COVID-19

Prior law under the CARES Act stated that any EIDL Advance received would reduce PPP Loan Forgiveness, essentially requiring the EIDL Advance to be repaid.  This provision has been repealed, so the receipt of an EIDL Advance will have no impact on PPP loan forgiveness and essentially would not be required to be repaid.  It is yet to be determined if a borrower has already applied for forgiveness of their PPP loan if the SBA will automatically forgive the $10,000 EIDL advance or if the borrower will have to amend their forgiveness application.

Although very complex and extensive the “Consolidated Appropriations Act, 2021 (CAA, 2021)” included a lot of provisions designed to give businesses hard hit financially some relief.  If you have any questions with or if you would like to discuss any of these provisions please contact your tax professional at Dermody, Burke & Brown, CPAs.

 

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.