As you read this, it’s likely that your lawmakers are working on the next Payroll Protection Program (PPP) package.
Hopefully, in this next package they will include a provision allowing you to deduct business expenses you pay with your PPP money.
Let me explain – in the CARES Act, Congress said:
For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from the gross income.
From what we know, lawmakers thought this meant the PPP loan forgiveness was tax-free for you. You probably thought that too; we sure did.
But then in late April, the IRS issued Notice 2020-32 that prevents PPP loan recipients from deducting business expenses that were paid using the PPP monies which give rise to forgiveness (defined payroll, rent, utilities and interest).
Two things to note here:
- The PPP loan and forgiveness is a good deal even if the expenses are not deductible.
- When the CARES Act was passed, it appears lawmakers thought the PPP Monies were tax-free and had not considered the expenses paid with the loan proceeds would not be deductible.
ABC Inc., an S corporation, receives a $100,000 PPP loan, spends it all on defined payroll and the lender forgives the $100,000.
On its 2020 tax return, ABC reports no PPP income (remember, it was tax free), but it may not deduct $100,000 of payroll expenses. The non-deduction creates $100,000 of net taxable income ABC, the S corporation, passes on to its sole shareholder, we’ll call him Bob.
Let’s say Bob is in the 45 percent tax bracket when you consider both his federal and state income taxes. Bob pays taxes of $45,000 on this income.
And assume ABC passes to Bob the $100,000 of tax-exempt income. This puts him ahead by $55,000 ($100,000-$45,000).
A good deal – sure!
However, with passage of the CARES Act, Congress was not making a good deal but simply providing ABC with money for it to remain afloat and continue paying its employees during the COVID-19 pandemic.
What If It’s Like We Thought It Was?
If the payroll were deductible, ABC would be ahead by both the $100,000 and the tax benefit of the payroll being deductible. This would give the company a better chance of continuing to pay its employees after the PPP loan and its forgiveness.
There’s no spend on payroll.
The self-employed person does not have to spend any PPP monies on interest, rent or utilities. He or she can achieve full forgiveness in 10.8 weeks based solely on the 2019 tax return.
In its “you can’t deduct it” notice (IRS Notice 2020-32), the IRS invokes IRC Section 265, but section 265 does not consider how the PPP treats forgiveness for the self-employed. It applies to expenses incurred for the purpose of earning or otherwise producing tax-exempt income.
For the Schedule C taxpayer, no such expenses to produce tax-exempt income need to be paid to achieve 100 percent forgiveness.
Lawmakers Upset with the IRS
Let’s start with the fact the IRS has a tough job. In many cases, the IRS is nothing more than a referee. If lawmakers fumble the tax law, the IRS has to call it.
Richard E. Neal, chairman of the committee on ways and means, jointly stated the IRS got this wrong and the intent of the CARES Act was for the PPP to be a tax-free grant.
The IRS has held firm. That puts the ball back into the lawmakers’ hands, and now it’s their turn.
This is where you come in.
Give Them a Nudge
Congress is working on additional COVID-19 legislation. We suspect you will see the new legislation enacted into law before congress recesses for its summer break on August 8, 2020.
That means things are moving quickly, and if you want your voice to be heard, you need to speak now.
Here’s what you can do to create the action you desire:
- S. 3612 is the Senate bill to make the PPP forgiveness money used to pay business expenses tax deductible. To express your “yea or nay” on S. 3612, contact your senators. You can find them at this link – https://www.senate.gov/general/contact
- H.R. 6821 is the House bill to make the PPP forgiveness oney used to pay business expenses tax deductible. To express your “yea or nay” on H.R. 6821, contact your representative. You can find them at this link – https://www.house.gov/representatives
You don’t need to be big and formal about your “yea or nay.” You can fax, email or phone and simply say you support or oppose the bill. It’s that easy — and it’s effective. DO IT!