Ppp Loan Forgiveness: Irs Clarifies Tax Implications
By: Jackie McGuire, CPA Client Service Manager
The Paycheck Protection Program established by the CARES Act in March 2020 provided loans to eligible small businesses. If the borrower used the loan proceeds to pay certain eligible expenses, then the amount of the loan up to eligible expenses could be forgiven and the loan forgiveness amount would not be treated as taxable income to the borrower.
However, the IRS issued Notice 2020-32 in April 2020. That notice states that expenses associated with tax-exempt income are not deductible. This IRS notice was consistent with historical IRS guidance regarding non-taxable income and related expenses.
Simply put, if the forgiven loan is not included in taxable income then the expenses paid with the forgiven loan are not to be included as tax deductions. Therefore, businesses could potentially have an unexpected tax liability at the end of the year.
Many business owners and financial planning practitioners alike were unhappy with the position that the IRS has taken because this guidance goes against Congresss intent when they created the PPP loans. The IRS Notice could negatively impact businesses that are still struggling.
On November 18, 2020, the IRS and Treasury issued much-awaited guidance in the form of Revenue Ruling 2020-27 and Revenue Procedure 2020-51 and clarified their position:
The criteria to be eligible for safe harbor includes the following:
Accumulated Adjustments Accounts And Ppp Loan Forgiveness
S corporations face another problem with PPP loansthe impact on the accumulated adjustments account which serves as the limit on S corporation distributions before the distributions are deemed to come out of any earnings and profits the corporation may have.
While a corporation that has always been an S corporation and never entered into any merger or similar transaction with a C corporation that resulted in the S corporation inheriting earnings and profits will not have earnings and profits while it remains an S corporation, that doesnt mean this isnt an issue. If that corporation terminates or revokes its S status, the balance in AAA determines how much can be distributed in the post termination transition period tax free.
Again, lets look at a simplified example. In this case the corporation entered 2020 with AAA of $100,000 and accumulated earnings and profits of $100,000. The corporation obtained a PPP loan in 2020 and obtained forgiveness the same year, spending the funds on expenses on which a deduction is claimed. The corporation makes no distributions in 2020, but does distribute $100,000 in 2021. In both years the company has $0 of income with no separately stated items of income or other sources of non-taxable income.
And now IRC §1368, which defines AAA, would seem to indicate that these expenses related to tax-exempt income would also not impact AAA:
Accumulated adjustments account
To Enter Ppp Expenses For Schedule C Schedule E Or Schedule F:
Go to the appropriate input screen and follow the steps below.
If there are no nonconforming states on a return, you don’t need to enter the deductible expenses that were paid with a forgiven PPP loan. The forgiven loan isn’t considered taxable income, and the expenses paid with it are still deductible for federal purposes.
Note: Additional state inputs for nonconformity from the IRC can be found on the State & Local Modifications screens.
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% Reduction From Gross Receipts
California conforms to the federal gross receipts test requiring a 25% or greater reduction in gross receipts and will therefore follow the rationale of this related federal guidance.
To Attach A Ppp Loan Forgiveness Statement:
The data youll enter include:
- PPP loan forgiven. This is the amount of income from a forgiven Paycheck Protection Program loan thats nontaxable for federal, but taxable to nonconforming states. Intuit ProConnect will automatically create a federal M-1 adjustment for this amount, as well.
- Expenses nondeductible to state related to a forgiven PPP loan. The Consolidated Appropriations Act made eligible expenses paid with forgiven PPP loan funds deductible on the federal return. Some states dont conform to this provision, so expenses paid with the loans aren’t deductible on those state returns. If your return doesnt include nonconforming states, you wont see this field.
- EIDL advance . This is the amount of Economic Injury Disaster Loan advance received that’s nontaxable for federal, but taxable to nonconforming states. ProConnect will automatically create a federal M-1 adjustment for this amount, as well.
Follow the steps for your return type to enter forgiven PPP loans or EIDL grants.
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Timing For Inclusion In Income Of Ppp Forgiveness
The AICPA specifically recommends the following on the issue of when a PPP loan should be deemed forgiven and the tax-exempt income be recognized:
The AICPA recommends that Treasury and the IRS issue guidance stating that the proper period under the Code for the inclusion of the tax-exempt income due to Section 276 is when the PPP borrower pays or incurs qualifying expenses during the covered forgiveness period. Additionally, the guidance should state an intention of Treasury and the IRS not to challenge treating the loan forgiveness as a ministerial act. The timing of applying for or receiving approval for PPP loan forgiveness is not relevant for this matching determination regardless of whether a taxpayer is a cash basis or accrual basis taxpayer.
The AICPA generally defends this recommended position as follows:
Taking into account tax-exempt income at the time the PPP funds are expended on qualifying expenses during the covered period provides better matching of income and expenditures for the vast majority of PPP borrowers. The terms and conditions of the PPP are defined by Congress and the SBA and the PPP borrowers obligations to obtain loan forgiveness are clear. Thus, submission of the PPP loan forgiveness application for many borrowers will be a ministerial process.
As well, the AICPA letter argues that Notice 2020-32 and Revenue Ruling 2020-27 support this view that the PPP loan forgiveness application is just such a ministerial act:
Nta Blog: Paycheck Protection Plan Loan Forgiveness And Deductibility Of Associated Expenses
As part of a suite of measures to provide small businesses relief from the impact of COVID-19, Congress established the Paycheck Protection Plan loan program in March 2020. Under the PPP loan program, eligible businesses could apply for a forgivable loan that, if used for payroll costs and certain other expenses within a certain period of time, would be eligible for loan forgiveness.
Although the rules for eligibility and terms of repayment evolved over time, the Small Business Administration oversaw the issuance of over five million PPP loans totaling over $525 billion during the first phase of the program. Congress recently passed legislation expanding the PPP loan program to include a second draw for eligible small businesses providing another $284 billion for new and second-draw loans.
From a federal taxation perspective, four aspects of the PPP loan program that I would like to highlight are the treatment of loan forgiveness, the deductibility of expenses, interplay with the Employee Retention Credit , and creditors rights.
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S Corporations And Ppp Loan Forgiveness
Attaining S corporation status has certain tax advantages. S corporations are treated as pass-through entities for tax purposes and the protection of shareholder assets. However, the relief acts passed in response to the COVID-19 pandemic revealed some potential problems with how income passed to individual shareholders is taxed. Two of the most relevant issues are discussed here.
Treatment of PPP loan forgiveness
The Coronavirus Aid, Relief, and Economic Security Act of 2020 created the Paycheck Protection Program. Under the PPP, some employers and some self-employed individuals were able to borrow money from the Small Business Administration. The loan proceeds they received could only be used for expenses used during the covered period. The covered period generally begins on the date the PPP funds are received and ends on a date between eight and 24 weeks thereafter.
The loan may be partially or fully forgiven if the business remains operational and keeps its employee counts and wages stable. If these conditions are not met, the loan must be repaid, but expenses paid with the loan proceeds are deductible under the usual rules.
Among the problems this creates is the following: If a shareholder has no basis in the loan, do nondeductible expenses reduce basis?
State and local taxes
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Can I Deduct Business Expenses I Paid With My Ppp Loans
It depends. To qualify for expense deductions, basis adjustments, and lack of reduction of tax attributes related to AB 80, you must meet the following qualifications.
- Your business cannot be publicly traded.
- You meet the 25% gross receipts reduction qualifications.
If your forgiven loan was an EIDL grant or Targeted EIDL advance, you are not required to meet these qualifications to deduct expenses.
If you do not qualify for the expense deductions under AB 80, California follows Rev. Rul. 2020-27, which may allow for some limited deductions.
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To Enter Eidl Grants For Schedule C Schedule E Or Schedule F:
If there are no nonconforming states on your return, you don’t need to enter the amount of EIDL advance received. The grant isn’t taxable income for federal purposes. The options below should only be used to include the EIDL amount as income on a state return when required.
- On the left-side menu, select State & Local, then click on Modifications. Select the state’s modification screen. Inputs available will vary based on the state tax return.
Business Taxes Are Not An Allowable Use Of Ppp Funds
The latest round of coronavirus relief also gives business owners more flexibility with how they spend PPP funds. Newly covered costs include protective equipment, property damage and business software.
Business taxes arent part of that expanded list. So if you use your PPP loan to pay your business taxes, that amount wont be forgiven.
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Are Ppp Loan Proceeds Taxable Income On My Tax Return If My Ppp Loan Was Forgiven Under Covid
No. Loan proceeds received under the Paycheck Protection Program are not taxable income, regardless if the loan was forgiven or not. Forgiven PPP loans are not considered cancellation of debt income, and as such, you should not report these loan proceeds on your tax return. This applies to all taxpayers, whether your business is a sole proprietorship, single-member LLC, partnership, multi-member LLC, corporation, or any other entity type.
In the TaxAct program, you will not be asked to enter any PPP loan proceeds information. The IRS is not requiring nor requesting this information on tax returns. You should enter your gross receipts and other income items as you normally would.
Does California Conform To The Exclusions For Other Sba Loan Forgiveness Or Grants
No, not at this time. AB 1577 and AB 80 only provide gross income exclusions for covered loan amounts forgiven pursuant to the CARES Act, the Paycheck Protection Program and Health Care Enhancement Act, the Paycheck Protection Program Flexibility Act of 2020, the CAA, EIDL grants under the CARES Act or targeted EIDL advances under the CAA.
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Time And Manner To Make Election
To make a valid election to apply the safe harbor, a covered taxpayer must attach the statement described below to the covered taxpayers timely filed, including extensions, federal income tax return or information return for the covered taxpayers first tax year following the covered taxpayers 2020 tax year in which the original eligible expenses were paid or incurred.
The statement must be titled Revenue Procedure 2021-20 Statement and include the following:
- The covered taxpayers name, address, and Social Security number or taxpayer identification number
- A statement that the covered taxpayer is applying the safe harbor in Rev. Proc. 2021-20
- The amount and date of disbursement of the taxpayers original PPP covered loan and
- A list, including descriptions and amounts, of the original eligible expenses paid or incurred by the covered taxpayer during the covered taxpayers 2020 tax year that are reported on the federal income tax return or information return for the first tax year following the 2020 tax year.
The revenue procedure is effective for any tax year ending in calendar year 2020 and for the immediately subsequent tax year.
Sally P. Schreiber, J.D., is a JofA senior editor.
Applying For Ppp Forgiveness
The SBA took its time coming up with the forgiveness application. It now has 3! Yes. Thats right. There are 3 different forgiveness applications for PPP loans.
Why so many you ask?
Well, they are meant for different business types, loan amounts and all the variations in between.
For most of you, Im guessing youre either a sole proprietor or possibly a single-owner S Corp.
As a sole proprietor, its pretty simple to apply for forgiveness as long as the bank that issued your PPP loan has its application ready to roll. Once it does, I suggest using the SBA 3508S if your PPP loan was under $50,000. Its the simplest application available. Youll need your business legal name, address, and other relevant information like your EIN or Social Security Number along with the following:
- SBA PPP loan number
- PPP Loan amount
- Disbursement date
- Employees at time of application and employees at time of forgiveness
- EIDL advance amount
- EIDL application number (if you applied for an EIDL loan in addition to the PPP Loan
- Forgiveness amount
- Your 2019 Schedule C
Im guessing most of you received less than $50,000 for your PPP loan. If you didnt, then you can use the SBA checklist to see if the 3508 EZ application will work for you. Its for those who didnt reduce pay, employees, etc.
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What Taxpayers Need To Know
Treatment of Loan ForgivenessUnder section 1106 of the Coronavirus Aid, Relief, and Economic Security Act, signed into law on March 27, 2020, an eligible recipient is eligible for forgiveness of indebtedness for all or a portion of the stated principal amount of a covered loan if certain conditions are satisfied .
Generally speaking, unless a specific exception or safe harbor applies, if a debt is canceled, the lender issues a Form 1099-C, Cancellation of Debt, to the borrower reflecting the amount of canceled debt. Section 1106 of the CARES Act, explicitly provided that or purposes of the Internal Revenue Code of 1986, any amount which would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection shall be excluded from gross income. The IRS further clarified in Announcement 2020-12 that, lenders not file information returns or furnish payee statements under to report the amount of qualifying forgiveness with respect to covered loans made under the Paycheck Protection Program administered by the Small Business Administration , in consultation with the Department of the Treasury.
Is There Any Special Process Or Form For Amending Returns To Claim The Newly
No, taxpayers should follow FTBs normal amended return procedures. However, if a taxpayer makes an election under Rev. Proc. 2021-20 for federal purposes, California will follow the federal treatment for California tax purposes.
Additionally, FTB does not anticipate creating any new forms to implement AB 80, but we are in the process of updating line item instructions.
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Data Entry For Ppp Loans For C And S
PPP loans included in book income and Schedule M-1 is printing
UltraTax CS reporting of data entry:
PPP loans included in book income and Schedule M-3 is printing