Tax Implications of the Paycheck Protection Program

COVID-19 has left millions of Americans asking questions – some of them no more or less complicated than “what do I do now?” To help answer this question and ease the minds of Americans, on March 27, 2020, Congress signed the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act.

In this $2.2 trillion economic stimulus bill was the Paycheck Protection Program (“PPP”), an incentive for employers to keep their workers on payroll. Many business owners were left wondering what tax implications this had for their businesses. The following information should help answer those questions.

Is it Taxable?

Is it taxable? The quick answer is no. According to Section 1106(i), “the CARES Act provides that any amount that would be includible in gross income of the recipient by reason of forgiveness of a PPP loan ‘shall be excluded from gross income.’”

Generally, the amount of a loan that is forgiven represents taxable income for income tax purposes in the year it is written off. However, "the CARES Act excludes from the gross income of a borrower any income that may arise from PPP loan forgiveness, regardless of whether such income would otherwise be properly characterized as income from the discharge of indebtedness." No income means no tax.

You are probably asking yourself, “so, if it’s not taxable, is it deductible?” This answer is a little more complicated, but luckily, the second stimulus package has helped clear it up.

Is it Deductible?

Under the first stimulus package and according to an IRS Guidance, since businesses aren’t taxed on the forgiven loan amount, they can’t deduct expenses paid by the loans—even if they haven’t yet filed for or received forgiveness. There is a reasonable expectation that these loans will be forgiven, so if a business is taking deductions on these loans, those deductions must stop.

Pursuant to provisions of the CARES Act, no deduction is allowed for an expense if the payment of the expense results in forgiveness of a covered loan. At first, this makes perfect sense. This is a loan that is being forgiven, a handout, so why should you get a benefit for it?

Well, this could actually lead to higher income taxes for companies. Here is an example: “a C corporation with a $1 million PPP loan which is forgiven for being used for otherwise deductible payroll costs will owe $210,000 ($1 million x 21 percent federal income tax rate applicable to C corporations) more in 2020 income tax than would be owed if the payroll costs were tax deductible.

The additional income taxes owed by owners of pass-through entities (sole proprietorships, partnerships, and S corporations) could be much greater since these entities are subject to 2020 federal income tax rates up to 37 percent.”

According to Bloomberg Law, “Democratic and Republican lawmakers have both opposed the IRS’s stance and signaled that they may allow for the expenses to be deducted under a forthcoming stimulus package.”

In late December 2020, Congress passed, and President Trump signed, a second COVID relief bill. This time, sensing the tax questions from the first bill were not going away, the Legislation created more clarity regarding the tax implications of COVID relief.

In CNBC’s breakdown of the tax implications of the second stimulus package, it says that businesses will now have the ability to “claim deductions for expenses covered by PPP loan proceeds.” Perhaps the non-deductibility of the loan was conceded because of the IRS’s weak argument.

The IRS argued that because of the loan’s potential forgiveness and expected reimbursement, it should not be allowed a deduction. However, this left taxpayers in a tough spot with the end of the year approaching. The new clarity of allowing deductions to be claimed will ease the minds of many.

In addition, "firms that received a cash advance through the Economic Injury Disaster Loan program also will no longer have to deduct the advance from their PPP loan forgiveness amount.”

Some argue that it is “too little, too late” and that there may be limitations/guardrails to come. But for now, the ability to claim deductions is a welcome sign for business owners.

If you are a small business owner, you may be entitled to a second loan, if you have fewer than 300 employees and have seen drops at least 25 percent of revenue during the first, second, or third quarter of 2020.

Expanded Meal Deduction

The new COVID relief package had a few controversial pieces. One such piece was the expansion of the meal deduction. The new expansion will last through 2022, and will allow companies to deduct 100 percent of business meals with clients instead of the current 50 percent.

President Trump shared support of the provision in a tweet, which read it would, “bring restaurants, and everything related, back – and stronger than ever. Move quickly, they will all be saved!”

Supporters of the provision believe it will be a good tax break for businesses hard hit by COVID, as well as support for the restaurant industry which has been crushed under pandemic regulations.

However, those who are against it question the effectiveness of the provision because many restaurants are closed right now due to COVID. Some have dubbed this provision the “three-martini lunch tax deduction.”

Critics believe this does not belong in the bill and that the government should be doing more to help lower income individuals and people who have lost their jobs due to COVID.

According to Market Watch, Democrats agreed to keep the expanded meal deduction in exchange for expansion of tax credits for low-income families. The Earned Income Tax Credit (“EITC”) is a tax break for households that make between $1 and $50,000.

The Child Tax Credit and the Additional Child Tax Credit (“ACTC”) are also tied to income. Because these tax credits are tied to income, many people can lose these credits if they lost their job due to COVID.

However, the new legislation lets taxpayers look back and apply their 2019 earned income for purposes of the EITC and the ACTC. Although there are opponents of the expanded meal deduction, if servers who lost their job can keep their tax credits and the if the expanded meal deduction can actually help restaurants, this COVID relief package could help one of the industries hit the hardest in 2020.

Payroll Tax Deferral

In another effort to lessen the tax burden, on August 8, 2020, President Trump issued an executive order to give a "payroll tax holiday," which took effect on September 1, 2020. "The initiative allowed, but did not require, employers to defer the 6.2 percent Social Security tax paid by employees until the end of the year."

This payroll tax holiday only applies to individuals with bi-weekly wages below $4,000. Many were still left asking how long the deferral will last.

The IRS and Treasury Department issued a guidance shortly after President Trump’s executive order. Accordingly, employers are required to remit the deferred taxes between January 1 and April 30, 2021.

If you are an employer who deferred 2020 payroll taxes, you are still responsible for paying them back. However, the IRS and the Treasury issued this guidance note: “if necessary, the Affected Taxpayer may make arrangements to otherwise collect the total Applicable Taxes from the employee.” Due to this deferral, employers and/or employees may have large tax liability in 2021.

Conclusion

If you are an employer or an employee who has had one or multiple questions about what the COVID relief packages could mean for you tax-wise, I hope that I’ve answered them. If I’ve missed any, please call my office. We can set up some time to have a conversation about your concerns. We can also address any issues that could affect your upcoming individual or business tax returns.