Potential Tax Implications of PPP Loans and More
The following PPP loan topics have seen recent changes / updates due to government activity:
1. Loan Forgiveness
a. Sole Proprietors, Independent contractors, and Self-Employed Individuals with no employees can use SBA Form 3508EZ. This straightforward form is intended to provide the simplest of business structures an easy way to apply for full loan forgiveness. Therefore, if you have no employees or even if you file 1099s for sub-contractors, you will use this form. [There are a few other businesses that might be eligible to use this form, but we can review those circumstances on a case by case basis.]
b. All other PPP loan applicants will file SBA Form 3508. This application will require more detail, specifically around the number of FTE’s (full time equivalent employees). Diligent recordkeeping is still required in this instance.
In all scenarios, PPP lenders may now accept scanned copies of Forms 3508 & 3508EZ to avoid in-person meetings.
2. Loan Principal and Interest
A common question is whether borrowers need to begin loan repayment while they await a decision on forgiveness. The answer is “no.” All lenders will be notified by their banker if all or any part of the PPP loan is not forgiven. At that time, the borrower will be informed of repayment details before the first payment is due. As such, all PPP Loan participants who have applied for forgiveness should await the results without any repayment activity undertaken.
3. Taxability of PPP Loans
Cancellation of debt income: In general, the reduction or cancellation of non-PPP indebtedness results in cancellation of debt (COD) income to the debtor, which may affect a debtor’s tax bill. However, the forgiveness of PPP debt is excluded from gross income. Your tax attributes (net operating losses, credits, capital and passive activity loss carryovers, and basis) wouldn’t generally be reduced on account of this exclusion.
Expenses paid with loan proceeds
The IRS has stated that expenses paid with proceeds of PPP loans can’t be deducted, because the loans are forgiven without you having taxable COD income. Therefore, the proceeds are, in effect, tax-exempt income. Expenses allocable to tax-exempt income are nondeductible, because deducting the expenses would result in a double tax benefit.
However, the IRS’s position on this issue has been criticized and some members of Congress have argued that the denial of the deduction for these expenses is inconsistent with legislative intent. Congress may pass new legislation directing IRS to allow deductions for expenses paid with PPP loan proceeds.
PPP Audits
Be aware that leaders at the U.S. Treasury and the Small Business Administration recently announced that recipients of PPP loans of $2 million or more should expect an audit if they apply for loan forgiveness. This safe harbor will protect smaller borrowers from PPP audits based on good faith certifications. However, government leaders have stated that there may be audits of smaller PPP loans if they see possible misuse of funds.
4. Congressional Discussions (but not yet law)
It should be noted that Congress is debating a simpler loan forgiveness process for all borrowers under $150,000 with an easy “check the box” certification form, but this has not yet been approved. In the present political climate, we are unsure if anything will pass, so it is prudent to prepare under the assumption that full details are required for all loans.
There are also discussions presently being held to reopen the PPP Loan program a second time, for businesses to apply for another forgivable loan if they can attest to an approximate 50% decline in year on year revenue.
At this time however, no legislation for either item has been passed.
SKP Recommendations
Only one bank that we know of has the loan forgiveness application available; even they are suggesting that clients hold off on applying because the rules are still subject to change. Most banks are waiting until mid-September to begin accepting applications in case the rules do change. It is likely that any changes to the existing filing would simplify the process so we see no adverse effect in waiting to apply. Therefore, we agree that waiting is the best course of action. SKP recommends not filing a forgiveness application at this time, and instead look for further guidance from us as the process unfolds.
As always, we are here to help navigate, formulate a strategy, and prepare the loan forgiveness application with you. Contact us when we can be of assistance.
