The process for seeking the forgiveness of government-backed loans made under the Paycheck Protection Program can be complicated, and deciding how to treat these expenses for tax purposes can create an additional layer of difficulty.
One of the keys to simplifying the loan forgiveness process is to focus on the funds that were used for payroll, said Brian Smith, director of compliance for Restaurant Solutions Inc., a restaurant consulting firm.
At least 60 percent of the total funds that businesses received from the program, which began in April and was modified in June, needs to be spent on wages and related costs in order for the loan to be forgiven. No more than 40 percent can be used for other operating costs, including rent, mortgage interest, and utilities.
It’s important that businesses have the paperwork that supports their request for forgiveness and covers the appropriate time frame, Smith said.
“We see businesses struggling with the calculations and coming up with the documentation, just because of the complexity of the application,” he said. “If they are trying to do it on their own, they are having a hard time getting their documentation together.”
The PPP loan can cover all payroll compensation, with the exception of wages that were paid under the Emergency Paid Sick Leave Act. Businesses can receive tax credit for those wages, however. In addition to wages that are eligible for loan forgiveness, businesses can also include the employer portion of health insurance and payments toward retirement funds. Payroll taxes, however, are not eligible for forgiveness.
In June, the Paycheck Protection Program Flexibility Act expanded the time frame covered by the loans to 24 weeks, from an original span of eight weeks. Many small businesses that remained open will likely find that their gross payroll costs for that period consumed most or all of their PPP loans.
“It they got a $100,000 loan and they had $100,000 in payroll costs in that 24 weeks, that's going to streamline the process of applying for loan forgiveness,” said Smith. “If payroll costs were 100 percent of the loan, that’s the only number they have to worry about.”
Even if payroll costs only accounted for 80 or 90 percent of a company’s loan, it will still make the application for forgiveness easier to apply for, he said, because payroll costs will tend to be easier to document than other forgivable costs.
“The closer they can get to 100 percent payroll costs, the more it will help their cause when they're going through the process,” said Smith.
If companies reduced the wages they paid during the period, that could also impact how much of their loan will be forgiven.
Companies that received a PPP loan should apply through their lender. Borrowers can apply for forgiveness any time before the loan matures. If they do not apply for forgiveness, companies must begin repayment of their loans within 10 months after the end of the 24-week period covered by the loan, in most cases.
Deduction Questions Remain
Meanwhile, many companies are still in limbo about whether or not the expenses paid for with loan funds will be eligible for tax deduction.
According to the most recent ruling issued by the IRS, businesses cannot claim expenses paid for using PPP loans as tax deductions if they have a reasonable expectation that the loans will be forgiven. If operators have not yet applied for loan forgiveness, they should probably proceed as if nothing they paid for using the loan funds will be deductible as an expense, according to Smith.
“They took away a tax planning strategy for a lot of businesses, almost at the last minute,” he said. “So, you're just going to have to assume none of these expenses are deductible, and you're going to have to be the most conservative, and basically pay taxes on your PPP loan.
“The bright spot is that if you received a $100,000 loan, paying taxes on $100,000 is a hell of a lot better than having to repay $100,000,” Smith said.
He said Congress may at some point consider allowing expenses covered by the loans to be tax-deductible, but the IRS is constrained by existing law dictating that expenses paid for with government grants cannot be deducted.
“The IRS is combining current law with the CARES Act, and trying to interpret how they interact together, and no one likes what they came out with,” said Smith. “So, my hope is that it pushes Congress to make the law. I hope they see the suffering that's going on right now in some of these small businesses, and that they just put their differences aside and give the Americans that are suffering some financial assistance.”
Related: PPP Loan Deadline Extended to August 8; Billions of Dollars Still Available in Small Business Funds.
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