Deductible Expenses and Forgiveness for PPP Loans

The Deduction or Forgiveness Choice – It’s either/or but not both.

When the CARES Act was passed earlier this year, one of the unanswered questions on everyone’s mind was whether or not expenses paid with forgiven PPP funds would be able to be deducted. Under the latest guidance from the IRS and Treasury Department, if you expect partial or full PPP loan forgiveness, you are not allowed to write off expenses paid for by forgiven loan money. This applies whether you have applied for forgiveness or have yet to submit your application, as these expenses are applied in the year in which they are paid or incurred. This forces borrowers to choose between the deductions or loan forgiveness.

Congress hopes to modify the language to allow borrowers to deduct these expenses even if their loans are forgiven. Until then, careful consideration of how this new guidance will affect your business or nonprofit will help determine the best option for you.

Under the current guidance, being unable to deduct expenses relating to payroll, rent and utilities that were paid for with forgiven PPP loan money may make income appear higher at tax time, resulting in a higher tax obligation. Proactive tax planning is paramount. It’s important to speak with your advisor now so that you can take appropriate mitigation steps before the end of the year so you aren’t surprised with a higher that usual tax bill in April.

Generally, we are recommending most clients temporarily hold their application for forgiveness, so long as they are still within the 10 month application window. However, this doesn’t mean sitting and waiting for Congress’ next move. We recommend planning a few possible scenarios based on the current guidance and possible modifications to the language. In some cases, borrowers may find their best option is to apply for partial PPP loan forgiveness or to forgo the forgiveness and keep the favorable loan rate on your books as a debt, as this will allow these expenses to be deducted. Your advisor can provide some scenarios for you now so that you can make any necessary adjustments before year end after we hear more from Congress in early December.

It’s important to note that there is a safe harbor provision for taxpayers who do not deduct expenses because they anticipate PPP loan forgiveness but are denied in whole or in part, or later decide not to request forgiveness.

Keep in mind that if you choose to forgo forgiveness or apply for partial forgiveness for your business or nonprofit, you need to consider how this impacts financial covenants with your lender. It’s important to talk to your lender about waiving or adjusting any financial covenant requirements. We can help you navigate these terms with your lender.

Even with this new guidance, there’s a chance that future legislation could allow deductibility of these expenses but there is no guarantee. We cannot stress enough how important tax planning and strategy has become for 2020. We expect to hear more and will update you as information becomes available. In the meantime, you should review your particular situation with your advisor to determine your best course of action.

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