PPP Loan Forgiveness and Taxation Issues

[JohnH]

So has anyone had recent discussions with clients on the issue of taxes and PPP loan forgiveness?  I've encountered two clients who had read in several places that when the PPP loan is converted to a grant, it is not treated as taxable forgiven debt.  But they failed to read further and find that the IRS position is that the expenses paid with these same funds are not deductible. Even when we tell them about IRS Notice 2020-32, they aren't likely to read it.  And unless Congress acts, they will wind up paying taxes on the forgiven debt anyhow.

I've tried several approaches in explain this, but am still not satisfied with how clear I am being. And having to introduce the uncertainty based on whether Congress acts to clear this up just makes things even more confusing.  (It's a much worse problem than trying to make a restaurant owner understand why they can't take a tax deduction for food they discard. )

I guess this falls into under the heading that "It's hard for a man to understand something if understanding it will cost him money."  I sure hope Congress gets busy at some point (either pre-election or post-election), and provides some clarity on this important issue.

[jklcpa]

2 hours ago, JohnH said:

I've tried several approaches in explain this

I'd probably try the "paid with money not earned or generated by your business" or "the gov't footed the bill, no deduction."

If that doesn't work, try "no deduction, it's the law, end of story."

[Lee B]

I have advised my clients with PPP loans of the taxation problem. My advice to them is to plan on waiting until next year since they have 10 months from the end

of their expense window before they have to apply. Hopefully legislation will be passed to resolve this problem. This may also require their tax returns to go on extension,

so that we know exactly what we're dealing with before we file.

 

[BulldogTom]

Deferring the tax hit into next year is a valid strategy.   But one of my clients asked "What if Biden wins and the tax rate on my corp goes from 21% to 39% next year?" and I did not have an answer.   Usually, tax deferral is a great strategy but there are so many unknowns that I don't know what to say.

Tom
Modesto, CA

[Lee B]

12 hours ago, BulldogTom said:

Deferring the tax hit into next year is a valid strategy.   But one of my clients asked "What if Biden wins and the tax rate on my corp goes from 21% to 39% next year?" and I did not have an answer.   Usually, tax deferral is a great strategy but there are so many unknowns that I don't know what to say.

Tom
Modesto, CA

Since the expenses paid by the forgiven PPP Loan are 2020 expenses, what I am trying avoid is  having to go back and amend 2020 by extending and delaying the filing

of 2020 tax returns. 

[Catherine]

15 hours ago, BulldogTom said:

there are so many unknowns that I don't know what to say

This is when you use the phrase "Magic 8-ball says 'Answer Hazy; Ask Again later'!"

  

[GLJEANNE]

I've been struggling with this also.  I've told people that if the PPP isn't income, they can't take the deduction, and they seem to get that.  A colleague suggested creating new accounts under Payroll, Rent, etc called PPP Reduction to credit out the expenses.  If the forgiveness doesn't happen until 2021, not sure what to debit it against.  I suppose we could do Expected Forgiveness of Loan or some such nonsense.
 

[Lee B]

1 hour ago, GLJEANNE said:

I've been struggling with this also.  I've told people that if the PPP isn't income, they can't take the deduction, and they seem to get that.  A colleague suggested creating new accounts under Payroll, Rent, etc called PPP Reduction to credit out the expenses.  If the forgiveness doesn't happen until 2021, not sure what to debit it against.  I suppose we could do Expected Forgiveness of Loan or some such nonsense.
 

I wouldn't do that. What you have is a M-1 adjustment, a Book Tax Difference. No changes on the Books.

[Abby Normal]

3 hours ago, cbslee said:

I wouldn't do that. What you have is a M-1 adjustment, a Book Tax Difference. No changes on the Books.

If the loan is on the books, which it should be, then there will be no M1 adjustment because the amount of the cancellation of debt income will be the same on both book and tax.

The question becomes, if you reasonably know how much of the debt is forgivable at 12/31/20, do you record that much forgiveness as of 12/31/20? I would say yes, because if you reasonably know how much will be forgiven based on 2020 expenditures, then you have no basis to maintain the full amount of the loan on your balance sheet... unless there's reason to believe that a new administration will be able to make the forgiveness not taxable.

And I'm of a mind to show it as cancellation of debt income on both the books and the tax return. It doesn't change taxable income and it's simpler and less work.

[Lee B]

2 hours ago, Abby Normal said:

If the loan is on the books, which it should be, then there will be no M1 adjustment because the amount of the cancellation of debt income will be the same on both book and tax.

The question becomes, if you reasonably know how much of the debt is forgivable at 12/31/20, do you record that much forgiveness as of 12/31/20? I would say yes, because if you reasonably know how much will be forgiven based on 2020 expenditures, then you have no basis to maintain the full amount of the loan on your balance sheet... unless there's reason to believe that a new administration will be able to make the forgiveness not taxable.

And I'm of a mind to show it as cancellation of debt income on both the books and the tax return. It doesn't change taxable income and it's simpler and less work.

When I first read your post, I agreed with what you said. But after thinking about it, I think that it's quite likely that a law will be passed next year that will make the

these expenses deductible. Second how do you record forgiveness income as of 12/31/20 if the application hasn't been filed? Third, where do you show nontaxable

forgiveness of debt income on the tax return?

[JohnH]

Thanks for all the perspectives.  My particular focus was the frustration with the partial information that's floating around. People can read that the income is not considered taxable as debt forgiveness and then the article stops, or else if the article tells the whole story the client fails to read it all or "conveniently" forgets the other part.  There isn't much to do other than tell them the whole story and then watch the puzzled expression on their face.

Interesting turn this conversation has taken.  Accounting for the PPP loan on the tax return might be challenging in several ways, depending upon what Congress does (if anything).  What about preparing an interim financial statement?  Say a client needs a Sept 30, 2020 financial statement for a lender.  Do we need to reduce payroll/rent expense to reflect the anticipated loan forgiveness, add a line item at the bottom of the financial statement with a title such as "Anticipated PPP loan forgiveness", or just ignore the expected loan forgiveness since it hasn't yet been processed & approved?  In the last scenario the financial statement can look pretty ugly, in the first scenario it can look too rosy, but in the middle scenario there is full disclosure. This might be considered the "Goldilocks" conundrum.  

[GLJEANNE]

Posting to the Reduction of Payroll account was the suggestion of a friend who does Corp Returns, which I don't, based on what she expects to need to need to report.  Agree that we have no way of knowing what if anything the next Congress will do, but we might not know until February.  I think I'll put this in place for both Corporate and Sole Prop clients, and then revise the books if needed after taxes are filed.

The other helpful part of this is that then the main Payroll expense accounts will still match the W2s.

[Abby Normal]

21 hours ago, cbslee said:

how do you record forgiveness income as of 12/31/20 if the application hasn't been filed?

Simply do an interim calculation based on what you know at the time the return is being filed. A pro forma application.

2020 will likely be a good year to extend all corporations to give time for the picture to become clearer.

[JohnH]

I did prepare a 2020 YTD statement through 3rd quarter today for a client, and it really looks wierd.  These are not actual numbers, but similar.  The client received a $200K PPP loan, which was spent appropriately.  

The conventional financial statement showed a $180k net loss.  Then I added a line item entitled "Anticipated PPP Loan Forgiveness-Payroll" in the amount of $150k, a second line item entitled "Anticipated PPP Loan Forgiveness-Rent/Util" in the amount of $50k.  Both these line items were negative entries under "Other Expenses".  So the net income after Other Expenses is $20K.

The client does seem to meet the requirement for loan forgiveness, but of course it hasn't happened yet.  In any case, the lender can see both scenarios and make their lending decision accordingly.  At least everything is disclosed, and I'm assuming the lender will understand.  If not, guess I'll be doing some explaining shortly.  

[BulldogTom]

15 hours ago, JohnH said:

At least everything is disclosed

I think that is appropriate, and that is all you can do.

Tom
Modesto, CA

[Medlin Software, Dennis]

I discussed the issue with myself yesterday (a reminder really), as I was filling out my forgiveness app.  It was a nice break from chuckling at how the employee SS deferral keeps costing more for any employer (and now the employees who "benefited") who elected that option (having to issue W2, then W2C).