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Is PPP loan forgiveness taxable, and are expenses deductible?

Nov 18, 2020
By: Curt Barnekoff
Agribusiness

This year, many agricultural producers applied for and received a Paycheck Protection Program (PPP) loan — gaining some quick cash flow and the potential to have the loan forgiven. But PPP loans have also come with tax implications, unanswered questions and planning opportunities.

What is the income taxability of PPP loan forgiveness?

The CARES Act, which created the program, stated that PPP loan forgiveness is excluded from income. Then, in Notice 2020-32, the IRS stated that expenses associated with the tax-free loan forgiveness income would be nondeductible. So, when we look at the income taxability of PPP loan forgiveness, what will the ultimate result be? Is it taxable? Is it not taxable?

As of right now, legislation has been proposed to address this question, but it has not passed into law.

If we do work off the prediction that 1) the receipt of the PPP loan will not be taxable income and 2) the forgiveness of the PPP loan will result in the non-deductibility of expenses paid, to the extent the PPP loan is forgiven, then the most important issue becomes timing. When do you apply the non-deductibility of the expenses?

Under PPP, loan forgiveness occurs after the borrower applies for it, submits the appropriate documentation and receives confirmation from their lender of the loan amount forgiven by the SBA. The borrower has 10 months after the covered period to apply for loan forgiveness.

Two arguments on when to apply non-deductibility

Looking at when to apply the non-deductibility, there are two strong arguments. The IRS is likely to take the position that the expenses are not deductible at the time they were paid. This is based on a long-standing tax law that says expenses incurred to produce non-taxable income are not deductible. For most PPP loan recipients, this would mean that the payroll, rent, interest and other qualified payments are not deductible when they are paid.   

The other, more taxpayer-friendly argument would treat the qualifying expenses as deductions when the expenses are paid and, after the taxpayer completes all steps to obtain PPP loan forgiveness and receives notification that the loan is forgiven, the taxpayer would reduce their deductible expenses for the tax year forgiveness occurs in. For many of you, these events will occur in the same tax year. But if you have a tax fiscal year-end other than December 31, you won’t achieve forgiveness until the year after the qualified expenses are paid.

Which is the correct treatment? It’s unclear right now, and so ag producers will need to wait for legislation by Congress or further ruling by the IRS.

Planning opportunities

One option you have is to obtain a tax return extension so you can wait until the uncertainties are resolved.

Profitable operations should consider creating alternative incomes or deductions — such as deferred-sale grain contracts or asset purchases that qualify for fast depreciation elections — in order to maintain flexibility in calculating this year’s taxable income. By doing so, you can achieve your desired taxable income level regardless of the ultimate ruling on this PPP loan forgiveness matter.

There is even a chance that Congress could pass legislation providing both non-taxable treatment of the loan forgiveness and full deduction of the qualified expenses. This would be a rare double-dip tax benefit for ag producers, so we’ll have to wait and see if this happens.

Regardless, ag producers must perform careful analysis and planning in order to gain flexibility and control over their current-year tax liability. If you have any questions about this matter or want to discuss your situation, contact us.

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Author(s)

Curt Barnekoff, CPA
Partner
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