Business Expense Deductions from Cares Act PPP Loans
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) provides $350 billion of loan relief to small businesses with fewer than 500 employees (“Small Businesses”) through the Paycheck Protection Program (“PPP”). If Small Businesses primarily use loan funds for employee payroll, the loan will be forgiven. However, what is unclear is the tax treatment of deductible business expenses paid with forgiven PPP loan funds. We believe the better argument is that they should be able to be deducted.
Presently, the CARES Act has provided tax guidance on whether a forgiven loan is considered income. While the Internal Revenue Code (“IRC”), classifies a forgiven debt as income, due to the unprecedented circumstance of COVID-19, the CARES Act states that a forgiven PPP loan will not be considered income. In regards to deductible business expenses, the IRC allows for-profit businesses to deduct ordinary and necessary expenses, but provides that no deduction allocable to one or more classes of income, other than interest, wholly exempt from taxes shall be allowed. Conversely, the CARES Act does not provide tax guidance on the issue of how deductible business expenses are treated after a loan is forgiven. Congress is currently considering this issue and definitive guidance could be forthcoming. Until then, we believe a strong argument—both legal and political—can be advanced for the deductibility of such ordinary and necessary business expenses paid from forgiven PPP funds.
The funds provided by the CARES Act are to assist Small Businesses in maintaining operations and keeping employees paid, so that they are ready and able to resume normal business when the economy is re-opened. Because the CARES Act is silent as to the taxability of business expenses, the silence should be interpreted to allow for covered expenses, paid with forgiven PPP loan funds, to be deducted as ordinary and necessary expenses. This is logical for two reasons. First, in the absence of Congress exempting forgiven loans proceeds from being classified as income, the forgiven portion of the loan proceeds would be income and the ordinary and necessary expenses would be deductible against that (and other) income. Because Congress specifically exempted the forgiven loan proceeds from being classified as income but did not exempt the ordinary and necessary expenses from being deductible, they should still be able to be deductible. Second, the loan proceeds are only forgiven after the expense payments are made and subject to certain conditions—that they were used to pay covered expenses. At the time the expenses are made the loan will not have been forgiven, so the general rule, that expenses paid with loan proceeds are deductible, should apply.
EXPENSES PAID FROM FORGIVEN PPP FUNDS SHOULD BE DEDUCTIBLE EVEN IF THE FUNDS ARE CONSIDERED A GRANT
Some commentators have argued that the forgiven PPP funds are, in essence, a grant. This should make no difference as to the deductibility of the forgiven proceeds. The federal government defines grants as “a way the government funds your ideas and projects to provide public services and stimulate the economy.” Grants are provided to those who submit applications certifying that they will comply with the requirements for receiving grant funding and carry out the full terms and conditions of the grant. International Accounting Standard (“IAS”) 20 sets forth two approaches on how to account for grants and their expenses: (1) the capital approach where a grant is recognized outside profit or loss, or (2) the income approach where a grant is recognized in profit or loss over one or more periods. By following the IAS’s income approach, deductible business expenses may still be taken by grant recipients.
A PPP loan can be argued to be, in essence, a government grant to Small Business that provides economic relief. Like a grant, the PPP has stringent terms and conditions that Small Businesses must meet in order to have the loan forgiven. Specifically, that Small Businesses must primarily use loan funds for employee payroll. Given the similarities between a grant and a PPP loan, how deductible business expenses are handled by Small Businesses under the CARES Act should be modeled on how they are handled by grant recipients under the IAS. Accordingly, following the IAS’s income approach, Small Businesses should be allowed to take deductible business expenses under the CARES Act. Again, because Congress exempted any portion of the forgiven loan proceeds from being classified as income, but did not exempt expenses from being deductible, the forgiven proceeds should, logically, be deductible.
ALLOWING DEDUCTIONS PAID BY A FORGIVEN PPP LOAN WOULD PROVIDE $112 BILLION TO $160 BILLION IN TAX BENEFITS TO SMALL BUSINESSES
There is political argument in favor of the deductibility of expenses from forgiven PPP loan proceeds as well—the tax savings to small businesses will help stimulate the economy and further the purpose of the CARES Act. We estimate that Small Business tax rates will range between: (i) Federal Income tax: 24-30%; (ii) California Income Tax: 8-9.3%; and (iii) Self-Employment Tax: 0-7%. Modeling these estimated averages against the $350 billion available from the PPP loan proceeds yields additional tax benefits to Small Businesses in the range of $112 Billion to $160 Billion. In what is being considered the most significant impact to the United States economy since the great depression, it only makes sense from a political and economic perspective to allow the deductibility of ordinary and necessary expenses from forgiven PPP loan proceeds.
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