Taxation of Forgiveness of Paycheck Protection Program Loans

07/09/2020

By Chris Hesse Principal CliftonLarsonAllen Email T. 612.397.3071

Key insights

  • As many businesses begin to receive Paycheck Protection Program loan disbursements, questions are soon following.
  • Here’s what we know about how these loan funds will be taxed.
  • We’ll continue to share additional information as guidance is released.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act became law on Friday, March 27, 2020. The CARES Act included a new federally guaranteed Small Business Administration (SBA) loan program called the Paycheck Protection Program (PPP). The maximum PPP loan was based upon two and one-half months’ average payroll costs for the prior 12 months. If the business pays qualifying costs over the eight-week period beginning with the funding of the loan, the entire debt may be forgiven. Usually, the forgiveness of debt generates taxable income for the borrower. That may not be the case with PPP loan forgiveness.

The PPP is designed as a federally guaranteed loan program that becomes a federal grant to the extent of the debt forgiveness. Businesses need to understand the taxation of the forgiveness of debt.

Loan forgiveness

PPP loan forgiveness is based upon the eight-week period beginning with the initial funding of the loan. The sum of the following enter into the forgiveness computation: payroll costs; health insurance for paid sick, medical, or family leave; mortgage interest payments; rent; and utility payments. The mortgage, rent agreements, and utility agreements must have been in place before February 15, 2020. [For the sole proprietor, 8/52nds of the 2019 self-employment income is considered the forgiven amount.]

The SBA interim final rules state that at least 75% of the forgiveness amount must relate to payroll costs. Payroll costs should include compensation, health insurance, retirement pay, and state and local payroll taxes. The 75% test has been heavily criticized, in that the statute does not contain this limitation.

In addition to the foregoing limitations pertaining to expenses, the PPP reduces the loan forgiveness amount unless the business satisfies two tests: employee count and employee wages.

Taxation of PPP loan forgiveness

The CARES Act provides that the debt discharge of a PPP loan is excluded from the gross income of the business for federal income tax purposes. Forgiveness is limited, based upon the payment of qualifying expenses and the maintenance of employee count and compensation. Businesses shouldn’t assume full exclusion from taxable income, however. Tax professionals have raised concerns regarding the deductibility of expenses funded from tax-exempt income. Upon forgiveness, the PPP has the look and feel of a nontaxable federal grant.

It appears that Congress intended the PPP to be fully non-taxable with no effect on the deductibility of the expenses paid during the eight-week period. Guidance from the IRS and the Department of the Treasury is needed to confirm full deductibility of expenses. The American Institute of CPAs (AICPA) is requesting guidance from the IRS regarding the deductibility of the expenses.