AICPA challenging nondeductibility of PPP-related expenses
By Sally P. Schreiber, J.D. | May 1, 2020
The IRS released guidance (Notice 2020-32) to explain that a taxpayer that receives a loan through the Paycheck Protection Program (PPP) is not permitted to deduct expenses that are normally deductible under the Code, to the extent the expenses were reimbursed by a PPP loan that was then forgiven. The PPP was created by Section 1106 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), P.L. 116-136. Under Section 1106(b) of the CARES Act, an eligible recipient of a covered loan can receive forgiveness of indebtedness on the loan in an amount equal to the sum of payments made for the following expenses during the eight-week covered period beginning on the covered loan’s origination date: (1) payroll costs; (2) any payment of interest on any covered mortgage obligation; (3) any payment on any covered rent obligation; and (4) any covered utility payment. Section 1106(i) excludes from gross income any amount forgiven under the PPP.
The notice explains that, although the expenses paid by the PPP may be deductible under Sec. 162 as trade or business expenses or under Sec. 163 as interest, Sec. 265 disallows a deduction to a taxpayer for any amount otherwise allowable as a deduction to the taxpayer that is allocable to one or more classes of income other than interest (whether or not any amount of income of that class or classes is received or accrued) that is wholly exempt from the taxes imposed by Subtitle A of the Code. The purpose of Sec. 265 is to prevent a double benefit by preventing a deduction for excluded income.
According to the IRS, Sec. 265(a)(1) prohibits an otherwise allowable deduction under any provision of the Code, including Secs. 162 and 163, for the amount of any payment of an eligible Section 1106 expense to the extent of the resulting covered loan forgiveness (up to the aggregate amount forgiven) because that payment is allocable to tax-exempt income. This is consistent with the purpose of Sec. 265 to prevent a double tax benefit. The IRS cited Rev. Rul. 83-3 for the proposition that deductions must be decreased to the extent the associated expense is allocable to amounts excludable from gross income.
AICPA position
The CARES Act itself does not address whether deductions otherwise allowable under the Code for payments of eligible Section 1106 expenses by a recipient of a covered loan are allowed if the covered loan is subsequently forgiven as a result of the payment of those expenses.
The AICPA believes strongly that the IRS’s interpretation denying deductions of expenses forgiven under the PPP program is contrary to Congress’s intent. Chris Hesse, CPA, chair of the AICPA Tax Executive Committee, said: “In effect, the IRS guidance means that the taxability provision [Section 1106(i)] has no meaning. Why waste the ink to say that for purposes of the Code, the loan forgiveness is not includible in income, if the government will just take away deductions in the same amount?”
Because it believes the intent of the CARES Act was to allow businesses to deduct all of their ordinary and necessary expenses — including any expenses used in determining PPP covered costs — the AICPA plans to seek legislative clarification. “We’re hopeful that we’ll see movement on the legislative front early next week,” according to Edward Karl, CPA, AICPA vice president–Tax Policy & Advocacy.
The AICPA's Paycheck Protection Program Resources page houses resources and tools produced by the AICPA to help address the economic impact of the coronavirus.
For more news and reporting on the coronavirus and how CPAs can handle challenges related to the pandemic, visit the JofA’s coronavirus resources page.
For tax-related resources, visit the AICPA’s Coronavirus (COVID-19) Tax Resources page.
— Sally P. Schreiber, J.D., (Sally.Schreiber@aicpa-cima.com) is a JofA senior editor.
To our clients and friends,
We hope you and your families are all well and comfortable during these times. We have been working to keep on top of the current government programs relating to COVID-19 and wanted to share what we know now. Things are changing rapidly so we will try to update you as necessary.
2019 Tax Deadline
This has been changed to July 15th – this includes any payment outstanding and applies to individuals, C Corporations, trusts and estates. Many states including Maine have not yet issued guidance. As a firm, we are continuing as normal as we feel most clients either would want to know and plan for tax payments due or are due refunds and would like to receive these as soon as possible.
Update for March 31, 2020
The President signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act late last week. Purdy Powers is working to digest the implications for our business and individuals clients so that we can better advise you. This is a wide ranging piece of legislation, the impacts of which the business advisor community is still largely trying to understand. We will be sending out a series of e-mails in the coming days breaking down specific aspects of the new law and how it could be applied to your business. If you have any questions please reach back out to us.
This, the first such e-mail focuses on payroll tax relief. At the employer’s discretion, you can choose to delay payment of the 6.2% employer portion of social security payroll tax between March 27th, 2020 and December 31, 2020 to be paid in two installments, 50% at December 31, 2021 and 50% at December 31, 2022. One important exclusion is that you CANNOT defer these payments if you take part in the Paycheck Protection Program through a qualifying loan with your lender. Please note – we will send out communication regarding the Paycheck Protection Program in a separate e-mail.
This relief measure is meant to be an important tool to relieve pressure on cash flow for employers during the remainder of this year. The deferral applies to all employers and all payroll. You should be hearing from your payroll provider as they implement this. It should also be noted that this is a deferral of payment and not a reduction in tax, any deferred amount will need to be repaid as per the schedule above the cash flow for which will need to be planned for.
If you have not heard from your payroll provider please reach out to them to make sure they are considering your business as it pertains to this important piece of legislation.
A special note for self-employed persons – as you know, your self-employment tax is paid via estimated tax payments throughout the year – you do have the option of reducing your estimated tax payments for the year by the portion of your estimated tax payment that represents this 6.2% employer match of payroll tax. A quick calculations suggests that at the maximum level of SE income, the tax amounts to around $8,537 which could reduce required estimated tax payments by a maximum of $2,134 per quarter. Please let us know if you would like us to calculate this for your specific situation and advise on reduced quarterly estimated tax payments.
Last week, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act” H.R. 748) which is meant to address the economic fallout from the COVID-19 pandemic in the United States.
Both unprecedented in size and scope, the legislation is the largest-ever economic stimulus package, and it amounts to 10% of U.S. Gross Domestic Product. While it may take several months to sort out the specifics of the new law, we have attempted to address the most significant aspects for our business clients here.
Perhaps the most important thing you can do for your business right now in this time of uncertainty is to reach out to your bank/loan officer to start this process. Banks are wading through the specifics of this legislation as we all are but we anticipate huge demand for these loans. We believe that starting the process as soon as is possible is the best course for ultimately securing funding.
Paycheck Protection Program
Armed with $350 billion, the Paycheck Protection Program is an extension of the Small Business Administration 7(a) program designed to help small businesses keep workers employed and to help cover occupancy costs during the worst period of the economic impact from COVID-19. In short, it is intended to be a tax free partial revenue replacement program to allow deeply affected businesses hibernate through a period of severe economic disruption without making drastic long term operational changes. We strongly urge you to contact your lender immediately to further investigate this opportunity.
Eligible Businesses
To be eligible, businesses must have fewer than 500 employees, could be taxed as a S-Corporation, C-Corporation, LLC or Partnership, 501(c)(3) non-profit, a 501(1)(19) veteran’s organization or a Tribal business as described in 31(b)(2)(C) of the Small Business Act. Most importantly, small businesses are presumed to qualify for the program and small business owners must certify during the loan process that loan criteria has been met.
Forgivable Loan
The maximum forgivable loan is $10 million and is calculated as 2.5 times the average payroll costs as measured over the 12 preceding months prior to the loan origination date. The loan period is between February 15, 2020 and June 30, 2020. Eligible Payroll Costs include salaries, commissions, tips, certain employee benefits like health insurance and retirement benefits, state and local taxes, and certain payments to independent contractors. Excluded payroll costs are FICA and income tax withholdings, payments to individuals in excess of $100,000, and foreign employees. The first loan payment is due six months after the loan origination date but not more than a year. However, interest continues to accrue during the deferral period.
Payment Forgiveness
Borrowers under the Paycheck Protection Program are eligible for loan forgiveness equal to the amount spent during an eight week period after the loan origination date on payroll costs, interest payments on mortgages, payment of rent on any lease and payment on any utility for which service began before February 15, 2020. Amounts forgiven cannot exceed the cost of the loan. Cancellation of indebtedness will not be included in borrower’s taxable income. To get the full benefit of loan forgiveness, businesses must keep their employees and pay them at least 75% of their prior year compensation.
Loan forgiveness will be reduced proportionally by any reduction in employees retained compared to the prior year and reduced by the reduction in pay of any employee beyond 25 percent of their prior year compensation. Borrowers that re-hire workers previously laid off will not be penalized for having reduced payroll at the beginning of the period.
To apply for forgiveness, businesses must submit documentation regarding eligible uses of loan funds (payroll costs, mortgage interest, utilities, etc.) a certification that documents are true and correct, as well as the amount to be forgiven, and any other documentation the SBA Administrator deems necessary. Amounts not forgiven at the end of one year is carried forward as an ongoing loan with terms of a maximum of 10 years and at a maximum interest rate of 4%.
How to obtain at PPP Loan
PPP Loans are made by SBA-certified lenders (over 800 financial institutions currently), in all 50 states, through delegated authority from the SBA. SBA-certified lenders simply need to verify that a small business was in operation on February 15, 2020, and paid employee salaries and payroll taxes or paid independent contractors, as reported on Form 1099- MISC, for eligibility in the PPP. Thus, the process should be relatively simple.
Please see the attached resource from the U.S. Chamber of Commerce to help guide you with this process. Again, we strongly urge you to contact your lender immediately. Otherwise, please feel free to contact a member of your client service team with questions.
Download More Info Here
Small Business Loans
The SBA has established a website for loan resources related to COVID-19:
https://www.sba.gov/page/coronavirus-covid-19-small-business-guidance-loan-resources
FAME has done the same:
https://www.famemaine.com/business/programs/covid-19-relief-loan-programs/
*Note that this includes loans for individuals/employees
Sick Leave and Related Tax Credits
The Families First Coronavirus Response Act–this act requires small employers–those with fewer than 500 employees–to provide paid-leave benefits to employees affected by COVID-19 but also provides credits–possibly refundable–to assist small employers with paying these costs. Information regarding implementation and procedures for claiming credits is still forthcoming. https://www.irs.gov/newsroom/treasury-irs-and-labor-announce-plan-to-implement-coronavirus-related-paid-leave-for-workers-and-tax-credits-for-small-and-midsize-businesses-to-swiftly-recover-the-cost-of-providing-coronavirus
Employee Assistance
Many employers are searching to find ways to help their employees who are impacted by COVID-19. One option is to take advantage of an existing statute, Internal Revenue Code Section 139. Since COVID-19 has been declared a national emergency, this statute permits employers to make tax-free payments or reimbursements to employees as “qualified disaster payments.” Please click on the link below for some frequently asked questions about how employers can use Section 139 immediately to help employees cope with COVID-19.