Sometime back I wrote about the Paycheck Protection Program enacted as part of the CARES legislation. This program made loans to businesses to cover payroll and other operating expenses. The intent was to avoid layoffs.
The rules allowed for the loan to be forgiven provided the business showed proceeds were used for acceptable purposes. It was acceptable to maintain workers on the payroll with incidental uses for other business expenses.
Many New Mexico businesses obtained PPP loans. As might be expected there was some confusion about how the rules actually worked. This included whether a business would be able to qualify for forgiveness. Treasury announced it would review any loan in excess of $2 million for program compliance.
We always hear that business hates uncertainty. The PPP had much of it. I want to address two. First, can a business deduct the expenses paid with loan proceeds? Second, how will prospective buyers of a PPP business view the loan?
A business may deduct ordinary and necessary business expenses. Payroll, rent, utilities and so on are qualified expenses. These are also the expenses that may be paid from a PPP loan and allow for loan forgiveness.
Another tax rule says that expenses funded by income wholly exempt from taxes under the income tax provisions of the tax law cannot be deducted. CARES said that PPP loan forgiveness would not be income.
Loan forgiveness usually triggers income to the borrower. This is so because the borrower ends up with loan proceeds – an economic benefit, that never had to be repaid. Certain provisions allow this debt cancellation income to be excluded. These provisions often only allow a deferral of the income to the future.
Deferred income is not exempted income. CARES loan forgiveness is not provided for in the income tax laws – CARES is its own law.
Many smart tax people say that expenses paid by a business from PPP loan proceeds can be deducted. They say it fails to fit the provision that no deduction is allowed if expenses are paid from exempt income.
Their logic is (1) CARES intended to provide a tax benefit for the exclusion of forgiven income, and this benefit is lost if offset by a denied deduction; (2) income is exempt under CARES, it is not income exempt under the income tax laws.
So one argument is no deduction because, well, it’s not fair. The other is parsing the language like a Philadelphia lawyer.
IRS says we won’t accept either argument. No income for forgiveness, no deduction. Many people claim this means the issue is settled. IRS does not settle tax disputes. IRS argues the government position. You and I can argue our position.
A bill was introduced to allow the deduction. It has not gone anywhere. The chairs of the two congressional tax writing committees say they think the deduction should be allowed.
The issue may be resolved by legislation by next tax filing season. Or it may not be. The not be will create uncertainty. Some fine tax practitioners will claim the deduction for clients. Others may not. May you live in interesting times.
Let’s say a business gets a PPP loan but is still struggling. There are lots that are. A buyer comes along. The PPP money is gone. The loan is eligible for forgiveness, but the business must prove certain things or pay back the loan. And if it was for more than $2 million it will be reviewed.
This is trouble. The buyer will inherit the potential liability to repay the loan. The buyer is likely to view the repayment risk as being more than the original lender. If so, the buyer is willing to pay less than the seller thinks is justified.
No one should be punished twice for the same offense. If a loan must be repaid there is no forgiveness income and hence no need to argue the income is exempt. Any expenses paid from the proceeds are then clearly deductible.
If the loan is not repaid there may be exempt income and then a contested deduction. The buyer may avoid the repayment liability but, depending on the business structure, be responsible for an IRS assessment for disallowed deductions.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.