IRS Issues Ruling on Paycheck Protection Program Forgiveness
This week, the Internal Revenue Service issued guidance on PPP loan forgiveness via Revenue Ruling 2020-27, which can be found here: https://www.irs.gov/pub/irs-drop/rr-20-27.pdf. Don’t worry, I will summarize it for you with examples. First a little background.
BACKGROUND
In April 2020, Congress passed the CARES Act that allowed for a Paycheck Protection Program (PPP) loan from the Small Business Administration (SBA). If used properly, those loans may be forgiven and not required to be repaid. At the same time, the SBA began issuing Economic Injury Disaster Loans (EIDL). The EIDL loans are required to be paid back. However, the SBA issued an emergency advance on that loan to applicants equal to $1,000 for every employee on the payroll, up to $10,000. This advance is not required to be paid back.
HOWEVER…
If you received both the PPP loan and the EIDL Advance, you will have a loan to repay. The EIDL Advance will reduce your forgiveness on the PPP dollar for dollar. For example, if your PPP loan was $100,000, and you received an EIDL Advance of $8,000, your potential forgiveness for the PPP loan is $92,000.
PPP Loan Proceeds $100,000
Less: EIDL Advance (8,000)
Maximum PPP Forgiveness $ 92,000
On May 2, 2020, the IRS released Notice 2020-32 which clarified that NO DEDUCTION IS ALLOWED for any eligible expense if the payment of that expense results in forgiveness of a covered loan.
Translation: If you received a PPP loan and used it to pay salaries, then had that loan forgiven, those salaries are not deductible on your tax return.
Under the terms of the CARES Act, the forgiveness of the loan will not be treated as taxable income to you. Therefore, technically, you did not pay for the salaries mentioned in the previous paragraph and cannot deduct it on your tax return.
This was the first time we learned the PPP loans would increase tax liabilities.
On June 5, Congress expanded the scope of PPP funds usage and increased the covered period through the end of the year. As the months dragged on without any further movement from Congress on the matter, banks across the country dragged their feet on offering forgiveness application portals to their borrowers. Of the few that did accept forgiveness applications, the SBA took 90 days or longer to approve them.
THE ACCOUNTING ISSUE
Fast-forward to October. PPP loans are starting to come due. Banks don’t know what to do and are not prepared for forgiveness applications to begin flooding in. Congress is busy with things that have nothing to do with this loan package. Accountants across the country are scratching heads.
What do we do if the loan expenses are in one year and the forgiveness is in another? The PPP loan money has all been spent as instructed. Forgiveness applications are elusive, and taxpayers have to begin preparing for their 2020 income taxes to ensure they have enough tax paid in.
IRS REVENUE RULING 2020-27
Rev. Rul. 2020-27 states:
“A taxpayer that received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.”
Translation: If you have a PPP loan and plan to apply for forgiveness now or in the future, you may not deduct the expenses paid with those funds in 2020.
WHAT DOES THIS MEAN FOR YOU?
Months ago, I wrote a blog post about how to restructure your chart of accounts to separate the expenses paid with PPP loan proceeds. Regardless of whether you changed your chart of accounts around or something similar, consider taking the following steps.
- Make a decision about your company books.
- Do you want your Income Statement (P&L) to reflect normal operations and show the non-deductible expenses for management use and budgeting? OR
- Do you want your accounting system to reflect your income tax filings?
There are good arguments for both situations. I have no intention of trying to persuade you in one direction or another. Neither is right nor wrong. Once you decide, continue on for further steps.
- Get a tax projection completed now. We now know that the expenses in 2020 will not be deductible in 2020. If you have not planned for this before, this will dramatically affect your taxable income for 2020. Before getting caught with an extra $100,000 in net taxable income, you need to know how this will change your taxes. Here is an example of the potential impact.
Tax Based on 2020 Rates 2020 Net Operating Income Before Forgiveness $ 85,000.00 $ 11,762.00 Reduction of Expenses (PPP Loan Forgiveness) 92,000.00 EIDL Advance Received 8,000.00 2020 Taxable Income $185,000.00 $ 36,247.50 - If you received the EIDL Advance, be sure to record that as Other Income on your Income Statement. This money is taxable.
- If you choose 1a, prepare a schedule of non-deductible expenses to present to your tax preparer at tax time and keep it with your permanent income tax records so you have a clean “Book-to-Tax” reconciliation to refer to years from now when you wonder why your income tax return shows higher income than your accounting system.
- If you choose 1b above. Read on for specific suggestions for your accounting system.
PREPARE YOUR ACCOUNTING SYSTEM
For the following, we will assume:
PPP Loan of $100,000
EIDL Advance of $8,000
Year-to-Date Salary Expense of $250,000
- Create a Long-Term Liability account called PPP Loan Payable.
- Reclassify your PPP loan proceeds to that account, if it is not already there.
- Create an Other Income account called EIDL Advance
- Reclassify your EIDL Advance to the new account, if it is not already there.
- Calculate your potential forgiveness. For simplicity, we will assume the entire loan is forgivable except for the EIDL Advance.
- Reduce the PPP Loan Payable account by the amount of potential forgiveness.
Debit PPP Loan Payable $92,000
Credit Salaries Expense $92,000
- Check the ending balances
- PPP Loan payable $8,000
- EIDL Other Income $8,000
- Salaries Expense $158,000
FREQUENTLY ASKED QUESTIONS
| QUESTION | ANSWER |
| What if my loan forgiveness is denied or I decide to just pay back the loan? | Rev. Proc 2020-51 provides a safe harbor to allow those expenses to be deducted. |
| Is the EIDL Advance Taxable? | Yes, in all cases the EIDL Advance is Taxable Income |
| Is the EIDL Taxable? | No, the EIDL is a loan that must be repaid and is not taxable. |
| I received CARES grants from my state/local government. Are they taxable? | Yes, those grants are taxable income |