Life and Taxes
It has been said that there are only two things for certain in this world: “Death and taxes.” That said, there are some significant differences in these two certainties. That is where Life and Taxes come from this month! Regarding the first, it is a one-time finite event. The second can be an ongoing issue and, in some cases, follow you even beyond the first certainty. While we may not spend much time contemplating the first certainty, each year as we approach year-end, we may find ourselves consumed with the second.
Life and Taxes
This year may introduce some unique planning questions for year-end tax planning for businesses. Especially those that participated in the Payroll Protection Program (PPP). An article from September 8, 2020 entitled, “How PPP Forgiveness Could Impact Taxes and Financial Reporting” written by Torre Hammer, Partner, Financial Statement Audit Services and Sarah McKnight, Senior Manager, Tax Services for Moss Adams highlighted some challenges that borrowers (and, to a lesser extent, lenders) will face for tax years 2020 and 2021.
At issue is that the CARES Act, which provided the PPP loan relief program. It contemplated that the loan forgiveness for covered expenses would not be included as taxable income for federal tax purposes. However, the IRS issued Notice 2020-32 in April 2020 stating expenses associated with tax-free income are not deductible, thereby effectively reversing the tax-free benefit of the exclusion of loan-forgiveness proceeds from gross income. The IRS Notice doesn’t appear to align with Congress’ expressed intent. However, it is consistent with other rulings as related to tax-free income; unless there is a change to the federal law, the IRS is unlikely to change its opinion. Several advocacy groups, including the AICPA, have argued that this violates the intent of the CARES Act. However, until the legislation changes, the current standard applies. Expect to see the issue addressed in any forthcoming COVID relief legislation.
PPP Tax Challenges
The challenges come into play as it relates to potential timing differences between when expenses were incurred and when the loan forgiveness occurs. To get a clearer understanding, let’s consider the timeline for loan forgiveness. The borrower could choose a “covered period” of 8 or 24 weeks or a cutoff within that range. The borrower then has 10 months from the end of the covered period to apply for forgiveness from the lender. The lender then has 60 days to render a decision and request payment from the SBA. The SBA then has 90 days to remit payment to the lender.
Under this timeline, the borrower will be well into 2021 before they are notified that their loan has been forgiven. Under current guidance, expenses associated with the forgiven loan are not deductible. This leaves the borrower with the question of whether the forgiveness increases income in 2020 when the proceeds were received and expenses incurred, or in 2021 when the borrower receives confirmation of the loan forgiveness. If the borrower files their 2020 return before forgiveness has been determined, should they deduct expenses related to PPP funds? Or disallow assuming the loan will be forgiven? If they deduct the expenses, what happens when the loan is forgiven?
File an Extension?
This may be a good argument to file an extension. This would be with the hope that PPP loan forgiveness and impact on expense deductions will be addressed and enacted in future tax law changes. In the interim, borrowers will still need to determine estimated tax and any estimated tax payments for a 2020 extension.
The implications of this tax treatment are not strictly related to federal taxes. It can impact state tax amounts, as well. In an article by Charles Jeanne, Assistant Chief Counsel of the SBA Office of Advocacy, entitled “Some States May Tax Forgiven PPP Loan Proceeds,” he highlighted that each state that has an income tax has some degree of conformity with federal tax law and IRS rules. Twenty-one (21) states and the District of Columbia have what is termed rolling conformity, which means taxable income automatically adjusts to current federal IRS rules and standards for both individuals and corporations. Others have varying dates. In the case of Wisconsin, the conformity date is 2017. However, in April 2020, the state legislature passed a bill to conform to federal IRS provisions on PPP loans. Other states, such as California, have already indicated their intention to tax PPP loan forgiveness.
Tax Pros Have Your Back
Does all of this sound like an argument for hiring a good tax professional to help navigate the various tax approaches and strategies? You would be correct!
Taxes may not be the only item that could be affected by treatment of PPP loans and their forgiveness. Borrowers and lenders will both need to consider how any PPP loans may impact bank covenants, as well. Accounting for PPP loans as debt could impact a borrower’s ability to meet certain loan covenants related to leverage. This would be things such as Debt to Equity or Debt to Cash Flow. In addition, cash flow calculations could also be impacted depending on how debt forgiveness may be considered in the cash flow and/or the offset of certain expenses. Thankfully, borrowers and lenders will not have to wait for Congress to act to work through these complexities!
While it may be true about the two certainties of life, we can probably add that as far as taxes are concerned, they will likely be cloaked in perplexity and confusion. Ahh… nothing like Life and Taxes!
Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape. We lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133.Tags: Enlighten Financial, Life and Taxes, PPP