Smart Tax Planning

Tax surprise awaits small businesses that can't deduct some expenses covered by PPP

Key Points
  • The Paycheck Protection Program, which came about as part of the CARES Act, offers entrepreneurs a forgivable loan they can use to cover eight weeks of payroll costs, mortgage interest and more.
  • The IRS said it won’t allow business owners to deduct wages paid and other expenses that are covered by the loan and forgiven. The agency also said the forgiveness itself won’t be subject to taxes.
  • If businesses can’t deduct wages and other expenses covered by PPP, they could wind up with higher income that’s subject to taxes, accountants said.
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A tax surprise could be around the corner for business owners who participate in the federal government's forgivable loan program — unless Congress intervenes.

The Paycheck Protection Program offers small businesses a lifeline in the form of a forgivable loan they can use to cover expenses including eight weeks of payroll costs and mortgage interest.

Demand for the aid was so high that the government rolled out a second round of funding on April 27, to the tune of $310 billion.

There's a catch, however.

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Business owners who take the loan won't be able to write off expenses that would otherwise be deductible if they use the PPP proceeds to cover the cost and get forgiveness, according to the IRS.

That could result in higher tax bills as entrepreneurs prepare to pay the first and second quarters' estimated taxes on July 15.

"When you're looking at the first quarters of the year and you're planning estimated tax payments, if you don't get the deductions for salaries and wages, it could create more income that you need to pay taxes on," said Dan Herron, CPA and principal of Elemental Wealth Advisors in San Luis Obispo, California.

Deductible or not

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The IRS's reasoning for blocking the deduction is to prevent PPP borrowers from obtaining what it calls a "double-tax benefit."

That is, the forgiveness of the PPP loan will be exempt from taxes, and permitting a write-off of salaries and other expenses in addition to that could be deemed double-dipping.

Lawmakers disagree with this. Sens. Chuck Grassley, R-Iowa, and Ron Wyden, D-Ore., proposed a bill that would permit small businesses to deduct those covered costs.

Sens. Marco Rubio, R-Fla.; Tom Carper, D-Del.; and John Cornyn, R-Texas, co-sponsored the legislation.

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"Unfortunately, Treasury and the IRS interpreted the law in a way that's preventing businesses from deducting expenses associated with PPP loans," Grassley said. "That's just the opposite of what we intended and should be fixed.

"This bill will do just that."

Deductibility of the expenses would give CPAs greater certainty on planning ahead for their business clients.

"You might print off your profit-loss statement and think you broke even this quarter, but if you can't deduct wages, you might have more profit than it seems," said Glen Birnbaum, CPA at Heinold Banwart in Peoria, Illinois. "That's what we're wrestling with."

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