PPP Loan and Tax deductions rules from Syed and Aadil
Recently passed Paycheck Protection Program (PPP) under Cares Act is a loan designed to incentivize small businesses to keep their workers on the payroll. The Small Business Administration (SBA) will forgive loans if all employees are kept on the payroll for eight weeks and the money is used for payroll, rent, mortgage interest, or utilities.
No taxes are due on the funds received as a PPP loan. You can submit a request to the lender that is servicing the loan for forgiveness. The request will include documents that verify the number of full-time equivalent employees and pay rates, as well as the payments on eligible mortgage, lease, and utility obligations. You must certify that the documents are true and that you used the forgiveness amount to keep employees and make eligible mortgage interest, rent, and utility payments. The lender must make a decision on the forgiveness within 60 days.
IRS notice Notice 2020-32 give additional guidance about the tax deductions provisions of the payroll, rent, mortgage interest etc. used from PPP loan funds. It clearly indicates that you cannot both take deductions as well as have free money from PPP forgivable loan amount to avoid double tax benefit.
In general, section 162 of the Code provides for a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Covered rent obligations, covered utility payments, and payroll costs consisting of wages and benefits paid to employees comprise typical trade or business expenses for which a deduction under section 162 of the Code generally is appropriate. Section 163(a) of the Code provides a deduction for certain interest paid or accrued during the taxable year on indebtedness, including interest paid or incurred on a mortgage obligation of a trade or business.
However, section 265(a)(1) of the Code and §1.265-1 of the Income Tax Regulations provide that no deduction is allowed to a taxpayer for any amount otherwise allowable as a deduction to such taxpayer that is allocable to one or more classes of income other than interest (whether or not any amount of income of that class or classes is received or accrued) wholly exempt from the taxes imposed by subtitle A of the Code. See generally section 265(a)(1); §1.265-1. The term “class of exempt income” means any class of income (whether or not any amount of income of such class is received or accrued) that is either wholly excluded from gross income under any provision of subtitle A of the Code or wholly exempt from the taxes imposed by subtitle A of the Code under the provisions of any other law. See §1.265-1(b)(1). The purpose of section 265 of the Code is to prevent a double tax benefit.
Also, PPP loan amount may be reduced if:
- 75/25 Rule is not met:
Examples:
| Approved Loan Amount | 50,000 | % Amount |
| Payroll Cost | 40,000 | 80% |
| Rent | 8,000 | 16% |
| Utility | 2,000 | 4% |
| Pass | 100% |
| Approved Loan Amount | 50,000 | % Amount |
| Payroll Cost | 32,500 | 65% |
| Rent | 15,000 | 30% |
| Utility | 2,500 | 5% |
| Fail | 100% |
- FTE Reduced Headcount:
Your loan forgiveness will be reduced if you decrease your full-time employee headcount
- Wages Reduce more than 25% for any employees:
Your loan forgiveness will also be reduced if you decrease salaries and wages by more than 25% for any employee that made less than $100,000 annualized in 2019.
Everyone’s circumstances are unique, so it is important to speak with a fiduciary financial advisor and CPA who can assess your financial and tax situation to provide guidance.
