As part of a suite of measures to provide small businesses relief from the impact of COVID-19, Congress established the Paycheck Protection Plan (PPP) loan program in March 2020. Under the PPP loan program, eligible businesses (those with no more than 500 employees) could apply for a forgivable loan that, if used for payroll costs and certain other expenses (e.g., rent, mortgage interest, utilities) within a certain period of time, would be eligible for loan forgiveness.
Although the rules for eligibility and terms of repayment evolved over time, the Small Business Administration oversaw the issuance of over five million PPP loans totaling over $525 billion during the first phase of the program. Congress recently passed legislation expanding the PPP loan program to include a second draw for eligible small businesses providing another $284 billion for new and second-draw loans.
From a federal taxation perspective, four aspects of the PPP loan program that I would like to highlight are the treatment of loan forgiveness, the deductibility of expenses, interplay with the Employee Retention Credit (ERC), and creditors’ rights.
Treatment of Loan Forgiveness
Under section 1106 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law on March 27, 2020, an eligible recipient is eligible for forgiveness of indebtedness for all or a portion of the stated principal amount of a covered loan if certain conditions are satisfied (qualifying forgiveness).
Generally speaking, unless a specific exception or safe harbor applies, if a debt is canceled, the lender issues a Form 1099-C, Cancellation of Debt, to the borrower reflecting the amount of canceled debt. Section 1106(i) of the CARES Act, explicitly provided that “[f]or 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.” The IRS further clarified in Announcement 2020-12 that, “lenders [should] not file information returns or furnish payee statements under [Internal Revenue Code (IRC) section 6050P] to report the amount of qualifying forgiveness with respect to covered loans made under the Paycheck Protection Program (PPP) administered by the Small Business Administration (SBA), in consultation with the Department of the Treasury.”
Deductibility of Expenses
The original PPP legislation did not explicitly allow borrowers to deduct the payroll, rent and other business expenses paid with PPP loan funds. On April 30, 2020, the IRS issued Notice 2020-32, that provided that to the extent the forgiven loan is excluded from gross income and results in a “class of exempt income,” IRC § 265(a)(1) disallows any otherwise allowable deduction to the extent of the resulting loan forgiveness. On November 18, 2020, the IRS issued Revenue Ruling 2020-27, amplifying Notice 2020-32 by declaring that borrowers may not deduct otherwise deductible expenses if the taxpayer “reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period.” In response to taxpayer concerns, Congress revised the law governing the PPP loan program to include explicit language in the Consolidated Appropriations Act of 2021 (enacted Dec. 27, 2020) providing that “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income” related to the forgiveness of PPP loans. The IRS acted swiftly to issue Revenue Ruling 2021-2, obsoleting both Notice 2020-32 and Revenue Ruling 2020-27 retroactive to tax years ending after March 27, 2020, and clarified that taxpayers are entitled to deductions even though forgiveness of the PPP loan does not result in additional gross income.
The IRS recently issued Revenue Procedure 2021-20 that clarifies that, if a taxpayer filed a return before December 27, 2020, and did not deduct certain expenses related to a PPP loan in reliance on now obsolete guidance, the taxpayer may amend its 2020 return to claim the expenses. Alternatively, Revenue Procedure 2021-20 provides a safe harbor by which the taxpayer may deduct the expenses in the subsequent tax year.
Unfortunately, from a state taxation perspective, things are a bit muddier. While Congress and the IRS are in accord regarding the tax treatment of PPP loans, not all states are on board with the federal tax treatment of PPP loans. Perhaps weary of a substantial loss of revenue, some state legislatures have decoupled (or are considering decoupling) from the federal treatment of PPP loan forgiveness and/or deductibility of PPP-eligible expenses. The Center on Budget and Policy Priorities estimates potential tax losses in the cumulative hundreds of millions in states, such as Maryland, Michigan, Montana, Nebraska, and Oregon, if they conform to the federal treatment. The American Institute of Certified Public Accountants reports that 32 states conform to the federal rule specifying that forgiven PPP loans won’t be taxed as income, while 24 states conform to the federal expense deductibility rule.
Interplay with Employee Retention Tax Credit
Beginning in December of 2020, businesses have the opportunity to secure a PPP loan and obtain the ERC for both 2020 and 2021. Section 2301 of the CARES Act, as originally enacted, provides a maximum credit of a $5,000 per employee for all of 2020 for qualified wages paid after March 12, 2020, and before January 1, 2021. Section 2301 of the CARES Act was amended and the ERC was extended by the Consolidated Appropriations Act of 2021 to provide a maximum credit of $7,000 per employee per calendar quarter for qualified wages paid January 1, 2021, through June 30, 2021(for a total maximum of $14,000 per employee for both the first and second calendar quarters combined).
Section 2301 of the CARES Act, as amended by the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (enacted into law December 27, 2020), provides that eligible employers that received a PPP loan may claim the ERC, with certain limitations. On March 1, 2021, the IRS issued guidance on the interplay between the PPP loan program and the ERC. IRS Notice 2021-20 explains when and how employers that received a PPP loan can claim the ERC for 2020. Notably, Notice 2021-20 clarifies that if a business obtained a PPP loan during 2020, it may claim the ERC for calendar quarters in 2020, as long as it does not claim the ERC on qualified wages included in the amount reported as payroll costs on a PPP loan forgiveness application.
Another area where states may differ from federal treatment of PPP loans is regarding creditors’ rights to funds received by businesses from the PPP. There is nothing in the CARES Act that expressly provides any exemption from garnishment or levy by creditors of PPP loan proceeds, but it did authorize the Secretary of Treasury to issue guidance regarding whether the funds are exempt or not. In January 2021, the IRS issued interim guidance instructing its employees not to levy on a bank account that contains PPP funds received within the prior 24 weeks. Some states have also taken the affirmative step to declare whether PPP funds are exempt from garnishment.
As small business owners are preparing to file their 2020 tax returns, they can rest assured that the tax treatment of PPP loans is as favorable to taxpayers as Congress intended. Borrowers are encouraged to check with their tax advisor to ensure they are complying with state tax rules, and to keep accurate records and retain for six years documentation of eligible expenses (the SBA reserves the right to review PPP loan applications and self-certifications). This Treasury website and IRS.gov contain FAQs and other helpful information about the PPP loan program.
The views expressed in this blog are solely those of the National Taxpayer Advocate. The National Taxpayer Advocate presents an independent taxpayer perspective that does not necessarily reflect the position of the IRS, the Treasury Department, or the Office of Management and Budget.