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SBA PPP: Income Tax Issues

on Tuesday, 13 October 2020 in Covid-19 Information Hub

The Federal income tax consequences related to Paycheck Protection Program (“PPP”) loans guaranteed by the Small Business Administration (“SBA”) continue to be an important, yet somewhat uncertain, consideration for all borrowers. Under regular Federal income tax principles, the forgiveness of a loan generally results in a business realizing cancellation of indebtedness income; however, the CARES Act expressly provides that any income realized as a result of forgiveness of a PPP loan is excluded from the business’ income.  {Nonetheless, the current IRS position leads to a result that, for economic purposes, results in a result similar to that of debt discharge income.}

In May, the Internal Revenue Service issued Notice 2020-32, which ruled that while forgiven PPP amounts will not be includible in income, corresponding business expenses paid with PPP funds that are forgiven will not be deductible. Our May 4, 2020 article summarizes Notice 2020-32 in more detail. While certain members of Congress have indicated a desire to reverse the position of the IRS, until such legislation is passed, borrowers should consider doing income tax planning now.

Once a borrower submits its Loan Forgiveness Application to its lender, the lender has 60 days to review and issue a decision to the SBA. After submission by the lender to the SBA, the SBA has 90 days to review the Application and remit the forgiveness amount to the lender. With these timelines in mind, many calendar-year taxpayer borrowers may not receive a determination of forgiveness prior to the end of the year.

Notice 2020-32 does not allow a borrower to take deductions for 2020, even if that borrower has not yet had its PPP loan forgiven. This creates a clear mismatch of income and deductions, but current law does not allow a different treatment. Depending on the tax status of the borrower, the timing of forgiveness and the related lack of deductions will have the following implications:

  • Partnership: For entities that are taxed as partnerships, both income and deductions will flow through to the partners. Even if income is stable as compared to prior years, the borrower partnership is likely to have decreased deductions due to the disallowance of deductions for eligible expenses such as payroll costs, interest on covered mortgage obligations, payment on covered rent obligation, or covered utility payments, to the extent paid using PPP funds. Because partners in a partnership are taxed on their phantom income (i.e., regardless of whether or not such income is distributed), partners should consider planning for an increased income tax liability or adjusting their annual distribution to account for the difference.
  • S Corporation: Similar to a partnership, the shareholders of an S corporation will likewise realize a decreased amount of deductions and thus an increased income tax liability.
  • C Corporation: C corporations may realize an increased tax liability at the entity level. While this will not directly affect shareholders, the increased tax bill for the corporation may indirectly affect the amount of money available for distribution.

These timing issues and related implications should be reviewed carefully. When analyzing eligibility, compliance, or other issues related to the PPP loans, both lenders and borrowers should ensure they have consulted the proper sources. If you have any questions regarding the SBA PPP loans, or other aspects of the CARES Act, please contact a Baird Holm LLP attorney.

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