The federal Paycheck Protection Program was, by most accounts, instrumental in helping to provide money for many small businesses through the pandemic. According to the Small Business Administration, the program — which ended Aug. 8 — provided more than five million forgivable loans to small companies, amounting to $525 billion. The loans were used not only to help keep their employees on the payroll, but also for other operating expenses such as rent and utilities.
Last week, the Senate failed to pass a bill that would have offered another round of PPP funding. But that wasn’t Washington’s only failure. Neither the Senate nor the House has addressed a ticking time bomb within the program: a potentially huge tax bill for recipients.
Let me explain.
Maybe your business, like many, struggled this year. But you’re still surviving. You didn’t suffer devastating losses like some in the restaurant, travel, fitness, retail or other consumer-facing industries. You didn’t grow, of course. But maybe you sold more online or you’re an essential business. Or perhaps you simply worked hard to continue to serve your commercial customers even while most of your employees worked from home.
Let’s say your revenues are close to last year’s levels. You continued to make your estimated tax payments this year based on last year’s results. Does this sound familiar? Many of my clients are in this situation.
And like many of my clients, you might have received a PPP loan to help you with your costs during these uncertain times and you’ve either applied or plan to apply for forgiveness. So here’s the problem: Even though you won’t be taxed for the forgiveness of the loan, you also can’t deduct the expenses applied to obtain forgiveness of that loan. Because of this, you could face a potentially significant tax problem.
Why? Let’s say your revenues and profits this year are close to last year and you received a $100,000 PPP loan, which you will seek to have forgiven with $100,000 of payroll and other eligible expenses. That’s great, except those $100,000 of expenses won’t be deductible. Which means you’ll have an extra $100,000 of income this year that you didn’t have last year. And if you haven’t increased your tax payments, you could be paying in far less than you owe.
Many financial advisers are concerned that businesses will overlook this problem and will inadvertently be faced with a huge tax bill. “Since cash flow was the primary priority for many of our clients, they weren’t as focused on whether the expenses would be deductible to the extent the portion of the PPP loans were forgiven,” said Jim Revels CPA, a Philadelphia-based partner in KPMG’s Private Enterprise Group.
Will Congress address this situation? Maybe. Industry groups, including the American Institute of Certified Public Accountants have been lobbying for a fix. But as I write this, no formal legislation is on the horizon, and as the year drags on, relief is becoming less likely.
Pennsylvania’s senators disagree about whether action is needed.
Bob Casey, the Democrat, said in a statement that he was “deeply disappointed” that the Republican majority in the Senate has not supported legislation to permit businesses to write off the expenses from their taxes.
But Pat Toomey, the Republican, believes that is’t logical. In a statement, his Senate office noted that people have always had to pay taxes on forgiven loans.
“Under the PPP program, however, as long as the loan is used for qualified expenses, its forgiveness is not treated as taxable income," the statement said. "Thus, an expense paid with a PPP loan costs a business nothing — the loan covers the expense and there is no tax on the loan forgiveness. It would not make sense for businesses to be able to deduct expenses they did not incur.”
Adrienne Straccione CPA, a partner at the Horsham-based accounting firm Wouch Maloney, believes that it remains difficult to predict what Congress might do.
“If no action is taken, many business owners will be disappointed,” she says. “Decisions were made, in part, based upon Congress' statement that loan forgiveness would not be included in income. Businesses could be forced to take out loans or find alternative sources of cash to pay the tax obligation.”
KPMG’s Revels agrees. He’s also concerned that it may be too late for Congress to act. “Inaction, though, could potentially cause a wave of small and even mid-size businesses to be unable to pay their tax bills, their other expense bills, claim bankruptcy, close their doors, or — the worst-case scenario — all of the above,” he said.
In the meantime, it’s critical that you meet with your accountant to determine the extent, if any, of this tax liability. And, if needed, make some moves.
Mitchell Gerstein CPA, a tax adviser at Isdaner & Co. in Bala Cynwyd, is advising affected clients to look for strategic investments that can reduce taxable income, such as hiring more talent, making capital investments that leverage accelerated depreciation rules, or deferring income and accelerating expenses.
Let’s hope that Congress does act before year’s end and makes these expenses deductible. But I wouldn’t count on it.