The 2020 tax season now looks a lot less bleak for those business owners who used Payroll Protection Program (PPP) money to cover their expenses to keep going during the coronavirus pandemic. On Dec. 21, Congress clarified rules on the program’s tax ramifications, leaving thousands of small-business owners the winners.
The months-long battle between the legislators who wrote the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the IRS appears to be over. (To read about the fight and how it affected business owners, check out IRS Leaves Business Owners Who Took PPP in a Tax Quandary.) Both the House and Senate have voted to approve the “Consolidated Appropriations Act, 2021.” Now it awaits President Trump’s signature, and while there is renewed wrangling going on about the bill, the dispute is about the amount of the stimulus payments, not the deductibility of business expenses.
Among the Act’s many provisions, is a subsection called the “Covid-related Tax Relief Act of 2020” (which starts on page 1,965 for those reading the full text). Under Section 276, Congress clarifies the tax treatment of forgiven PPP loans and the deductions paid by such loans.
Recall that the original Section 1106(i) of the CARES Act included language excluding forgiven PPP loan proceeds from taxable income but was silent on deductibility of expenses paid with those same proceeds. The Tax Relief Act amends the CARES Act to address this gap (which the IRS attempted to use as a backdoor to tax business owners on the relief funds’ benefits) with the bolded portion below:
TAX TREATMENT—For purposes of the Internal Revenue Code of 1986—
(1) no amount shall be included in the gross income of the eligible recipient by reason of forgiveness of indebtedness described in subsection (b),
(2) 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 provided by paragraph (1) ….
Although many (including myself) believe Congress made its original intent clear regarding taxability of PPP funds (and deductions) in the CARES Act text, subsequent positions taken by the IRS raised eyebrows – and questions – and, in the process, gave already-stressed small-business owners more to worry about.
Apparently wishing to leave no room for further misinterpretation, Congress went into greater detail with the Tax Relief Act, including additional language directed to pass-through income and tax basis of ownership interests. Additional provisions state:
(3) in the case of an eligible recipient that is a partnership or S corporation—
(A) any amount excluded from income by reason of paragraph (1) shall be treated as tax exempt income for purposes of sections 705 and 1366 of the Internal Revenue Code of 1986, and
(B) except as provided by the Secretary of the Treasury (or the Secretary’s delegate), any increase in the adjusted basis of a partner’s interest in a partnership under section 705 of the Internal Revenue Code of 1986 with respect to any amount described in subparagraph (A) shall equal the partner’s distributive share of deductions resulting from costs giving rise to forgiveness described in subsection (b).
This last part – “except as provided by the Secretary of Treasury” (the department that oversees the IRS) worried me, and I consulted with a tax expert, Rain Hughes, expert tax education provider and CEO of Fast Forward Academy, for insight. Hughes explains:
This language means that a partner’s tax basis shall increase by the distributable share of deductions attributed to forgiveness. This is meaningful because a taxpayer’s adjusted basis affects the taxation of distributions, the ability to recognize losses, and the amount of gain/loss recognized on disposition.
In other words, this language helps ensure business owners who receive the benefit now will not end up losing it in the form of capital gains later. This language prevents an end-run in another form of tax.
This is great news for business owners all over the country (including many of my clients) who took advantage of the CARES Act’s Payroll Protection Program to actually protect their payroll employees by keeping them employed earlier this year.
Imagine the struggling business owner (dentist, pediatrician, autism school, restaurant owner, or insert your own business) relying on PPP relief, who borrowed $250,000 and did not lay off any employees, even though business revenue dropped off substantially because everyone stayed home from April through July. If the PPP worked as intended, those proceeds helped carry the business through until things picked up by September. Everything may be looking good for a break-even year and a fresh eye toward a better 2021 – until the owner realizes she has an additional $250,000 in taxable income for 2020 and not enough in the bank to pay the tax bill. The ultimate irony would have had the IRS attempt to do what the coronavirus could not by putting those owners deeper in debt or out of business.
Thankfully, business owners no longer need to worry about such an absurd scenario, and we can now focus on a stronger recovery in 2021. All that now remains is for the president to sign the Act into law and we can all breathe a sigh of relief.