Small businesses all around the country have taken advantage of the Paycheck Protection Program (PPP), a federal program designed to help companies keep employees paid and their operations running during the COVID-19 pandemic.

Although widely successful, many questions surrounding PPP and the 2020 tax year have many taxpayers wary about the upcoming tax season, particularly the timing of income recognition and the deductibility of expenses.

Now that the IRS has released more guidance on the matter, here are answers to some of the most anticipated questions going into the 2020 tax season.

Why is timing such a critical issue?

The timeline associated with your PPP loan will play a complicated role in how your tax and financial planning efforts will unfold, particularly the lengthy process it takes to receive final debt forgiveness.

In March 2020, when the extent of the pandemic was broadly underestimated, Congress authorized $349 billion in forgivable loans to small businesses to meet their payroll expenses. Under the CARES Act, companies were granted to use PPP proceeds to cover payroll costs, mortgage interest, rent, and utilities for a covered period of eight consecutive weeks. When COVID-19 continued to wreak havoc on the economy far past those eight weeks, President Donald Trump signed the PPP Flexibility Act, effectively extending the length for a borrower’s covered period from eight to 24 weeks.

Regardless of the covered period chosen, businesses have ten months from the end of their covered period to apply for forgiveness. The lender then has 60 days to determine the application’s status and seek payment from the Small Business Association (SBA), at which point the SBA has 90 days to remit payment. Borrowers with denied applications have 30 days to contact their lenders and request a review by the SBA.

With this timeline, it’s likely many businesses will not know the status of their debt forgiveness until well into 2021, spurring many questions about how to treat those expenses incurred in 2020 on their tax returns.

How does my PPP loan affect tax planning?

According to Notice 2020-32, forgiven PPP debt is considered non-taxable income, and expenses paid with tax-exempt money become nondeductible expenses. Therefore, if the debt is forgiven, the funds used for salary, rent, utilities, and other qualified expenses will not be considered a deduction. This gives us debt forgiveness on one hand and disallowance of deductibility on the other. While unintentional, this IRS guidance effectively nullified the tax benefits intended to help businesses.

Prior to guidance recently released, the most pressing question was how to account for nondeductible expenses on their 2020 tax returns, specifically expenses paid with PPP loans when forgiveness status had yet to be determined. Luckily, we now have some clarity as to how to handle this situation.

What does the new guidance say?

Essentially, Revenue Ruling 2020-27 explains that if a business reasonably expects to receive loan forgiveness, then expenses should be treated as nondeductible in the 2020 tax year regardless if forgiveness status is unknown going into 2021. This effectively answers whether or not businesses should wait until loan forgiveness is established before treating PPP expenses as nondeductible.

But what if my lender doesn’t grant full loan forgiveness?

While Revenue Ruling 2020-27 put to rest one question, another came to light. If a business expected to receive full loan forgiveness and followed the above guidance for nondeductible expenses, what happens if their lender fails to grant full or partial forgiveness come 2021?

To answer this question, the IRS issued Revenue Procedure 2020-51, which poses two possible routes the business can pursue. First, the company can file an amended 2020 tax return to properly deduct the amount of expenses that were denied. Alternatively, the company may choose to treat the amount of expenses denied as a deductible on their 2021 tax return. Luckily, this offers businesses a little wiggle room should their forgiveness be partially or entirely denied.

What if I receive debt forgiveness in 2020?

This is perhaps the most straightforward situation for tax planning purposes. According to federal guidelines, if you applied and received loan forgiveness in 2020, then your PPP-related non-taxable income and nondeductible expenses fall in the same period.

What should I expect moving forward? 

Election year: As with all election years, a level of uncertainty is sure to affect tax and financial planning strategies. As transitions occur, we expect to have delays in legislation resolving the concerns surrounding PPP loan forgiveness.

Record keeping: Maintaining comprehensive records will play a pivotal role throughout the loan forgiveness process, particularly when it comes time to prove to the SBA the necessity of your loan. The SBA has a five-year statute of limitations to reassess forgiveness, and any loans over $2 million will receive an automatic review. Clear and concise records of all PPP loan spending will help expedite this process and minimize headaches down the road.

Audits: With increasing PPP fraud cases being found, businesses should expect to see a spike in the number of PPP-related audits. Maintaining accurate records will help aid this process should an audit occur.

Tax extensions: With new guidance continuously being issued, it may be advisable to file for a tax extension. A conversation with your tax advisor can help determine if this is the best option for your particular situation.

Stay informed: In the meantime, it is crucial to stay updated on current and evolving rules and regulations as they are released. The latest information can be found on the SBA website.

If you have any questions about your PPP loan or how it may affect your taxes, we are here to help. Please do not hesitate to contact us for more information.