Congress On the Verge of Giving PPP Borrowers an Early Christmas Present

December 21, 2020

On Sunday, both Democratic and Republican congressional leaders agreed on a $900 billion stimulus package which is expected to be approved by the House and Senate today.  The bill is intended, among other things, to clarify a major provision of the CARES Act passed in March 2020: the deductibility of expenses related to forgiven PPP loans.  If the stimulus package is passed as expected, small business owners will be able to deduct their payroll and other eligible expenses regardless of the IRS’s previous positions.

Background

The CARES Act created the Paycheck Protection Program (PPP) intended to issue forgivable loans to small businesses struggling with the economic impacts of the COVID-19 pandemic.  Loan forgiveness was contingent on using at least a portion of the funds to continue paying employees, with certain other expenses also eligible for forgiveness (namely rent, mortgage interest, and utilities for the borrowing business).

Another key provision of the CARES Act was a clarification that any amount of PPP loans that were forgiven were excluded from income taxes.  Normally, any forgiven debt is taxable as “cancellation of debt” (COD) income unless it meets certain statutory exceptions.  While the CARES Act language was clear that PPP loans were excluded from gross income, the IRS dropped a “bomb” of sorts in late April 2020.  The IRS stated in Notice 2020-32 that, because the forgiveness of a PPP loan is considered tax-exempt income, any expenses used to obtain forgiveness of PPP loans were not deductible citing Code Section 265.  Furthermore, the IRS doubled-down on its position in November with Revenue Ruling 2020-27.  It not only reinstated that the expenses would be nondeductible, but clarified that these eligible expenses could not be deducted if the business has a “reasonable expectation” that loan forgiveness would be received.  This would mean these expenses would be nondeductible even if loan forgiveness had not been received or even applied for as of December 31, 2020, as long as they were expected to receive forgiveness later.

By disallowing the deduction, the IRS was effectively still taxing PPP loan forgiveness – a stark contrast to the congressional intent of the CARES Act.  While lawmakers attempted to convince the Treasury to interpret the legislation differently, they received a response summarily saying, “If you want to change the tax consequences, then change the law.”  Previous attempts by congress members to pass a technical correction, or to attach a clarification to other bills, were unsuccessful.  Despite pressure from countless trade organizations and lobbyist groups, and general bipartisan support, it appeared that the unintended tax consequences of the PPP loan were here to stay.  That is, until talks resumed on a second stimulus package in December.

Now, with the expected passage of this stimulus bill, PPP loan borrowers can once again deduct their eligible expenses, avoiding the tax trap that had surprisingly ensnared them.

Important Things to Watch

1. Will The Bill Ultimately Pass? – While the stimulus package is widely expected to pass before Congress adjourns until 2021, there are a few congress members that are unhappy with some items that are substantially different than those agreed upon previously, and some that are unhappy with the procedure by which this bill has come to pass (only four leaders hammered out the details behind closed doors, quick passage a day later with no opportunity for amendments or changes, etc.).

2. Will There Be Any Limitations on Deductions? – Based upon the final text of the bill released for voting in the House, there are currently no limitations to claiming the related deductions and there is not supposed to be any changes made to the bill.  However, if any adjustments or amendments are ultimately allowed, there’s a possibility that the deductibility of PPP loan-related expenses could have limitations such as a phase-out (based upon income or loan size), overall cap on deductions, or even a borrower’s timing of application for loan forgiveness.

If this bill passes both the House and Senate with no changes (as expected), then Congress will have said, “Merry Christmas!” to all those small business owners who were (or will be) forgiven for PPP loans.