Struggling PPP borrowers have been on a roller coaster after seeing countless news headlines showing that Congress has yet to finalize their negotiations and pass the new COVID-19 stimulus bill.
But little has been written about whether the new law will allow PPP borrowers to deduct the expenses that they paid to receive forgiveness, and many PPP borrowers will not survive if they have a big tax bill for 2020 that is technically due by estimated payment on or before December 31st, 2020.
Those who do not pay enough into the system face penalties and interest as well, and must disclose this tax debt or risk thereof to lenders on financial statements and any required reporting.
The good news for most PPP borrowers is that the proposed bill allows for the deduction of these expenses, and for loan forgiveness to not be included in income. And borrowers that are S corporations will enjoy another benefit that is described below, as now written.
The bad news for many is that those borrowers who have received final forgiveness before the bill passes and is signed by the President will not be sure whether they can deduct the expenses or not, because the new saving provision described below will not apply to them. That would quite likely change after passing by technical correction due to the outcry that would obviously occur if this is the case.
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PPP Loan Deductibility:
For the majority of PPP borrowers, the only, but very significant change in the PPP rules will be to provide confirmation that they will not lose the income tax deduction that was expected to be available for expenses paid from PPP loans for items that are normally tax deductible.
While the original “Coronavirus Aid, Relief, and Economic Security Act” (“CARES Act”) made it clear that the forgiveness of a PPP loan would not be included in income, the proposed language for the new legislation clearly indicates that expenses paid with a PPP loan will be deductible using the normal rules associated therewith.
The vast majority of PPP borrowers use their loan money to pay wages, payroll tax expenses, utilities, rent, and interest, which are all normally tax deductible.
The new Act tax provision also indicates that any income tax basis increase that occurs as a result of receiving the loan will not be lost upon forgiveness of that loan.
As an example, the U.S. Supreme Court case of Gitlitz v. Commissioner found that the shareholder of an S corporation receives an increase in the tax basis for his or her stock to the extent loan money is received, even though the loan is later forgiven. This SCOTUS decision was reversed under Section 108(d)(7)(A) of the Internal Revenue Code, which was enacted shortly after the Gilitz decision and reads as follows:
(A) Certain provisions to be applied at corporate level:
In the case of an S corporation, subsections (a), (b), (c), and (g) shall be applied at the corporate level, including by not taking into account under section 1366(a) any amount excluded under subsection (a) of this section.
In this new Act, Congress is purposefully choosing to give PPP borrowers the same tax break that Mr. Gilitz received by not expanding Section 108 to include PPP loans.
As an example of the above, assume that Ma Kettle owns an S corporation and had a $200,000 basis in her stock on January 1st, 2020.
In that year she received a $500,000 PPP loan and spent the $500,000 on deductible expenses.
The loan was forgiven in 2021, and during 2021 she had $400,000 in revenues from the business and $400,000 of expenses.
She now has a $500,000 basis in her stock. If she sets the business down she will have a $500,000 capital loss that she would not have had but for the PPP program.
This may save her $100,000 in federal income tax by reducing her otherwise applicable capital gains. She can use this loss based upon $3,000 a year for any year that she does not have capital losses; plus, she can use this against capital gains each year until fully used. The last year when she must “use it or lose it” will be the 20th year following the capital loss (the tax year 2040 in the above example).
As a further example, assuming that Ma Kettle has a $500,000 capital loss in 2021 and no capital gains income, then she can use $3,000 of the loss against her ordinary income in 2022.
If she has $100,000 of capital gains in 2023 then she can offset those capital gains by her remaining capital loss carryforwards, and thereafter will have $373,000 in capital loss carryforwards that can continue to be used in the same way. This is not as good as the $900,000,000 ordinary loss carryforward that Donald Trump apparently claimed on his 1995 income tax return after the fall of the Trump Taj Mahal.
Deductibility for Independent Contractors, Sole Proprietors, and Farmers:
With all of the above being said, it is a very good thing for many PPP borrowers and a very good reason to shut down, sell, or gift S corporation ownership before the owner of an S corporation dies, considering that fact that, upon death, the basis of the S corporation stock held by the deceased individual will adjust downward to the fair market value of that stock.
The above discussion of tax deductibility of expenses paid with PPP loans likewise applies to assure independent contractors, sole proprietors, and farmers (by this we mean individuals who show their business income on a Schedule C or Schedule F of their personal income tax returns) that any and all expenses that are tax deductible for such individuals will be tax deductible in the normal fashion.
The PPP rules worked out very much to the advantage of these individuals because they are able to receive forgiveness of any loan amount not attributable to wages paid to individuals other than the owner.
Such individuals do not get to deduct the PPP forgiveness amount, but instead will receive the normal tax deductions that they are entitled to by reason of paying the business expenses. An independent contractor, sole proprietor, or farmer who simply received the PPP loan and spent it on personal expenses will not be able to deduct those expenses, but does not have to include the loan forgiveness amount in income.
We can all hope that by early next week we will turn on the news to see that a sufficient number of Senators and Congressmen have agreed on a new stimulus bill that will hopefully provide the applicable relief to all PPP borrowers.