Sometime in the next few days, the Paycheck Protection Program, or PPP, will restart. We’re just waiting now for the President to sign the bill the House and Senate already passed.
For the millions of small businesses who have borrowed PPP money, the new law includes a windfall. The PPP loan money now counts as truly tax free.
But let’s dig into the details very quickly. Because small businesses want to get this right.
No Cancellation of Debt Income
First, the new statute says PPP borrowers don’t add cancelled debt to their income.
The original statute always said this, by the way. But the IRS had found a backdoor way to make the PPP money taxable to most borrowers. And over the summer and fall, they’d issued several bits of guidance that said, basically, you need to pay taxes on the PPP money.
Congress reasserted their legislative authority here. No income from forgiveness!
Note: This earlier blog post is now out of date, but it describes the way the law worked before this latest bill.
No Lost Tax Deductions
That “backdoor way” the IRS employed to tax PPP loan proceeds? They said taxpayers couldn’t deduct spending funded with PPP money.
Example of old accounting: Your small business got a $50,000 PPP loan. You spent the $50,000 on payroll and so get full forgiveness. But you didn’t get to include the $50,000 as a tax deduction on your tax return.
Congress overruled the IRS’s earlier rules. The new law specifically says,
…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…
Just to beat this thing to death:
Example of new accounting: Your small business got a $50,000 PPP loan. You spent the $50,000 on payroll and so get full forgiveness. And you also get to include the $50,000 as a tax deduction on your tax return.
In effect, every taxable PPP borrower just received a tax benefit equal to 10 percent to 37 percent of their PPP loan.
The new law may give someone with a $10,000 PPP loan, for example, a bonus $1,000 of tax savings.
The new law may give someone with a $1,000,000 PPP loan a bonus $370,000 of tax savings.
Partnership and S Corporation Basis Increase
One final clarification appears in the law, thankfully.
The nontaxable cancellation of debt income a PPP borrower enjoys if she, he, or they follow the rules?
It adds to the partner or shareholder basis if the small business operates as a partnership or S corporation.
The new law provides the specific instructions your accountant will use, saying,
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).
Two quick examples to shine a light on this basis accounting business.
Example of a partnership: A partnership with two equal partners receives a $10,000 PPP loan. If the partnership receives full forgiveness of the loan, each partner receives $5,000 of basis.
Example of an S corporation: Two shareholders own an S corporation, one holding 75 percent of the shares and the other holding 25 percent of the shares. If the S corporation receives full forgiveness for a $100,000 loan, the 75 percent shareholder enjoys a $75,000 increase in her basis and the 25 shareholder enjoys a $25,000 increase in his basis.
The timing of the basis adjustment? Three thoughts here:
- First, we think taxpayers should be able to apply the earlier logic of IRS Revenue Ruling 2020-27 and bump their basis when they know with certainty they’ll receive forgiveness. But there’s of course no guidance from the IRS on this issue yet.
- Second, taxpayers may want to delay “using” the bump in basis from PPP loan until they officially receive forgiveness. By this we mean delaying a distribution, for example.
- Third, finally, taxpayers uncomfortable with the wishy-washy nature of this basis thing may want to extend their 2020 tax return. That extra time should surely mean a taxpayer will know with certainty a PPP loan either has or has not been forgiven.
Other Resources You Might Find Useful
We have a couple of blog posts over at Evergreen Small Business, our popular blog, that may be of interest to you:
PPP Second Draw Loans describes how especially hard hit small businesses can get a second PPP loan.
PPP Loan Amount Increases describes how you may be able to go back and get more money if you were short-changed by the bank on our original PPP loan.