Practitioners and taxpayers had a multitude of questions about eligibility for Paycheck Protection Program (PPP) loans. Those receiving the loans now have questions about loan forgiveness.
The Coronavirus Aid, Relief, and Economic Relief (CARES) Act was enacted to provide immediate assistance to individuals, families, and businesses affected by the COVID-19 (coronavirus) emergency. Among other provisions, the CARES Act authorizes the Small Business Administration (SBA) to temporarily guarantee loans under a new 7(a) loan program titled the Paycheck Protection Program (PPP).
Under the program, the SBA provides loans to small businesses to help pay up to eight weeks of payroll costs, mortgages, rent, and utilities during the COVID-19 crisis. All payments of principal, interest, and fees under the loans are deferred for at least six months. The loans are also forgiven for amounts of payroll costs, mortgage or rent obligations, and certain utility payments incurred between February 15 and June 30. The amount forgiven is excluded from an eligible recipient’s gross income for federal income tax purposes.
Are tax attributes reduced?
Practitioners have asked whether they must reduce tax attributes for the discharged PPP debt. A taxpayer usually must pay income tax on discharged debt. The taxable amount is the difference between:
- the amount the taxpayer owes on the debt; and
- any amount paid to settle the obligation.
However, taxpayers may exclude certain types of debt forgiveness from gross income. These include debt forgiveness in bankruptcy or insolvency and forgiveness of qualified farm debt. In these cases, if the taxpayer excludes this debt forgiveness, the taxpayer must reduce certain tax attributes by the excluded amount.
Unless the taxpayer elects to reduce the basis of depreciable assets, tax attributes are reduced in the following order:
- net operating losses (NOLs) or NOL carryovers;
- general business credit carryovers;
- minimum tax credit carryovers;
- net capital losses or capital loss carryovers;
- basis of the taxpayer’s property (depreciable and nondepreciable);
- passive activity loss and credit carryovers; and
- foreign tax credit carryovers.
Can businesses deduct costs subsidized by the loan?
To be eligible for PPP loan forgiveness and have the cancelled debt excluded from gross income for federal income tax purposes, the loan proceeds must be used for certain specified purposes. The amount eligible for forgiveness is the sum of the following costs incurred and payments made during the covered period:
- payroll costs;
- any payment of interest on any covered mortgage obligation on real or personal property that is a liability of the borrower incurred before February 15, 2020, in the ordinary course of a trade or business (it does not include any prepayment of principal);
- any payment on any covered rent obligation in force before February 15, 2020; and
- any covered utility payment for the distribution of electricity, gas, water, transportation, telephone, or internet access for service which began before February 15, 2020.
Practitioners have questioned whether they may still deduct these costs as business expenses if funded by the forgiven loan.
Should partners and S corporation shareholders increase basis by the forgiven amount?
Partnership and S corporation income increases a partner’s or shareholder’s basis in the entity. Partners and shareholders must increase their basis regardless of whether the income is taxable or tax-exempt. Practitioners have asked whether tax-exempt cancellation of debt income from a PPP loan increases basis.
IRS expected to issue guidance
The CARES Act simply states:
For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.
So, at present, these questions remain unanswered. However, the Act authorizes the IRS to “issue guidance and regulations implementing this section.”
During the loan application process, the SBA continually updated information on its website to resolve issues related to the application process and eligibility. For example, it clarified the status of independent contractors. In addition, Treasury added interim final rules for PPP loans to provide that no more than 25 percent of the forgiven amount may be attributable to non-payroll costs.
Expect additional future guidance from the IRS on tax issues related to PPP loan debt forgiveness.
Wolters Kluwer is by your side to help you stay up-to-date with tax and compliance changes and support your ability to work remotely. Please visit our Coronavirus (COVID-19) Resource Page for Tax & Accounting Professionals.
By Robert Recchia, J.D., M.B.A., C.P.A.