If you thought your business was going to deduct all those expenses you were planning to pay with a loan from the Paycheck Protection Program (PPP), you need to be aware of a new guideline the IRS has issued.
No Deduction For Expenses Made with PPP Loans
According to IRS Notice 2020-32, businesses cannot claim a tax deduction for an expense if:
1. The payment of the expense results in forgiveness of a PPP covered loan. This is true even for business expenses that are normally tax deductible. And,
2. The loan proceeds are excluded from gross income on a federal income tax return.
Normally, forgiven debt qualifies as taxable income. However, according to section 1106(i) of the CARES Act, forgiven PPP loans are not considered taxable income.
Although employee salaries are usually tax deductible, they won’t be on a business’s 2020 federal return if it pays them with a forgiven PPP loan.
Under the IRS’s new rule, PPP loan proceeds that are not forgiven can be used to pay deductible expenses.
Justification and Legal Framework
The IRS justifies its new guideline based on the assertion that deductions normally aren’t permitted on tax-exempt income. This view is based on the agency’s interpretation of Section 265 of the Internal Revenue Code.
As additional coronavirus legislation is expected from Congress, this issue could be further clarified or changed altogether in futures statutes.
Eligible Expenses with PPP Funds
Proceeds from a PPP loan can be used to meet payroll and various other expenses, including:
- Utilities (including water, gas, electric, internet, telephone, and fuel for vehicles)
- Business Mortgage interest
- Business Healthcare costs (including insurance premiums but excluding payments for HRA, HAS, and FSA)
- Rent for leases in place prior to February 15, 2020
- Interest on existing business debt
Amounts that are used during the first 8 weeks after a loan is issued can be forgiven if they are used within certain parameters. Here they are:
- Number of full-time employees must be maintained to attain at least 75% of the full time equivalent hours versus the prior year period.
- Wages and salaries must not be reduced by over 25% for employees who made less than $100,000 in 2019
- Any violations of these two rules can be corrected up until June 30, 2020 to reclaim eligibility for loan forgiveness
For both forgiven and unforgiven loans, at least 75% of funds must be spent on payroll. This includes retirement plan benefits, wages, and the employer’s portion of group health insurance. Self-employed persons cannot include retirement plan benefits or health insurance costs for the owner.
Need more help? Check out: How to Maximize Your PPP Loan Forgiveness.
The Employee Retention Credit
If the IRS’s new promulgation causes your business to hesitate on a PPP loan, you could instead opt for an Employee Retention Credit, another product of the CARES Act. This program offers refundable tax credits that can be applied to a business’s portion of employees’ Social Security taxes.
The purpose of Employee Retention Credits is to help businesses retain employees during the coronavirus outbreak. To be eligible, a business must:
(1) Have a decline in gross receipts in at least one quarter in 2020. Specifically, gross receipts have to be less than half of the same quarter’s gross receipts in 2019. Or,
(2) Postpone operations (partially or fully) at some point in 2020 due to a government mandate.
A credit is good for up to 50% of an employee’s wages, with a cap of $10,000 in wages. This results in a maximum of $5,000 in credit for each full-time employee a business keeps on the payroll from March 13, 2020 to December 31, 2020.
A business cannot accept both a PPP loan and an Employee Retention Credit.
Contact Glass Jacobson if you need any assistance managing the tax implications of the government’s coronavirus relief programs.
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