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The $900 billion COVID-19 stimulus package passed on December 27, 2020 contains a provision that will please many business owners.
The Consolidated Appropriations Act 2021 (CAA 2021), Section 276, “Clarification of Tax Treatment of Forgiveness of Covered Loans," allows Paycheck Protection Program (PPP) loan borrowers to deduct payroll and non-payroll expenses paid for with PPP loans on their federal income tax returns.
When initially rolled out through the CARES Act in March 2020, the Paycheck Protection Program specifically called for PPP loan money to be excluded from taxable income. However, the Act didn’t explicitly address the tax treatment of deductions that were funded with a borrower's PPP loan.
In April, the Treasury Department put a twist on its view of PPP money and ruled that instead of PPP funds being taxable income, the expenses associated with the PPP loan funds would be non-deductible.
In addition to holding the line on non-deductibility of PPP expenses, the Treasury Department issued further guidance in mid-November that stated, “if a business reasonably believed that their PPP loan would be forgiven, expenses related to the loan are non-deductible, whether the business has filed for forgiveness or not.” Essentially, any planning opportunities taxpayers thought they had over the timing or tax year of expense reduction was taken away.
Many leaders significantly opposed the Treasury’s disallowance of PPP expense deductibility. In August, a group of more than 170 businesses and trade associations urged Congress to allow businesses to deduct expenses paid for with forgiven PPP loans. Most groups that opposed the Treasury Department’s ruling argued that the disallowance of deductible expenses was not the intent of CARES Act at the time the Paycheck Protection Program was created, and business applied for and received loans based on the CARES Act.
The new legislation overrides the Treasury Department and the IRS's initial decision by providing that businesses are able deduct expenses funded with PPP loan proceeds. CAA 2021 clarifies that "no deduction shall denied, no tax attribute shall be reduced, and no basis increase shall be denied" by reason of the exclusion of loan forgiveness from taxable income. The legislation also clarifies that in the case of a partnership or S corporation, the loan forgiveness income shall be treated as tax-exempt income that is allocated to the partners or shareholders. As a result, pass-through entity owners will not have a reduction of basis in the pass-through entity as a result of the PPP loan. This treatment applies to original PPP loans as well as the second draw PPP loans.
The PPP provisions of CAA 2021 are retroactive and apply to tax years ending after the date of enactment of the Coronavirus Aid, Relief, and Economic Security (CARES) on March 27, 2020. Therefore, these rules apply to all taxpayers, even taxpayers who have already applied for or received forgiveness, as well as those who have already filed tax returns reporting expenditures as nondeductible.
If you have any PPP loan questions, don’t hesitate to reach out to your Delap advisor.