Personal Finance

Why third-quarter taxes are confusing for small businesses in the Paycheck Protection Program

Key Points
  • For filers who pay taxes on a quarterly basis, third-quarter estimates will be due on Sept. 15.
  • Business owners who took a forgivable loan via the Paycheck Protection Program continue to grapple with whether certain covered business expenses are deductible, even if they haven’t yet applied for forgiveness.
  • You may have to choose whether to deduct those expenses or not. If you don’t deduct the costs, you may be paying more in taxes.
Thomas Barwick | DigitalVision | Getty Images

A key tax deadline is just around the corner, and small-business owners who are in distress are still uncertain of what they'll owe the IRS.

For taxpayers who pay quarterly estimated taxes, Sept. 15 marks the due date for this year's third-quarter payment.

As if that weren't stressful enough, small businesses that took a forgivable loan through the Paycheck Protection Program still have no clue on how to treat certain business expenses that were covered by the loan.

PPP loans, which were established by the CARES Act, require that at least 60% of the proceeds be applied toward a business's payroll expenses to qualify for forgiveness.

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Here's the catch: While the IRS has said that the loan forgiveness itself is tax-free,  business expenses covered by the loan proceeds won't be deductible.

Members of Congress disagree with this finding and have sponsored legislation calling for the deductibility of those costs. Being unable to deduct the costs would make a  business's income seem higher on paper, which could raise their tax bill.

Business owners who haven't yet applied for forgiveness are facing a conundrum as the year winds down.

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House Democrats release results of PPP loan investigation

Do they count the expenses covered by the PPP loan and seek deductions for them when they hash out their third-quarter taxes? Or do they allow those items to be covered by the loan but avoid deducting the costs — which could result in a higher estimated tax payment for the third quarter?

"The problem is that they don't know if they're getting forgiveness and there's a good chance that someone who's applying for forgiveness won't know by the end of the year," said Ed Zollars, CPA at Thomas, Zollars & Lynch in Phoenix.

"Currently I would tell clients that if you want to be safe and we're talking about estimates, then treat the expenses as non-deductible so that you've overpaid," he said.

A forgiveness bottleneck

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The Small Business Administration, which is overseeing the PPP loan program, opened its window to accept forgiveness paperwork from banks in August.

However, applicants and tax professionals have been waiting for action from Congress to see if legislators finally address the deductibility issue before they apply. Banks have also held off on forgiveness in anticipation of possible regulatory and legislative changes.

As the year progresses, tax professionals are presenting clients with a choice: deduct the business expenses and potentially pay less in estimated taxes for now, or don't deduct the costs but possibly pay more in taxes for the quarter?

"You'll present them with the two situations," said Dan Herron, CPA and principal of Elemental Wealth Advisors in San Luis Obispo, California.

"Either they want to be conservative and pay in, and they don't care if they get a huge refund," he said. "Or some are aggressive and want to pay the least amount possible."

Appetite for risk

dowell | Moment | Getty Images

How a business owner might proceed depends on whether they're aggressive about tax savings, and if they have the cash to pay higher estimated taxes.

"You need to have the cash in the bank if you're going to be conservative," said Zollars. "You might decide to be aggressive if you don't."

Without an intervention from Congress, people who attempt to write  off business expenses that were covered by a PPP loan could owe the IRS down the line if the loan is forgiven.

Or they could wind up facing scrutiny from the taxman — a costly proposition if an entrepreneur tries to fight for the deductions in court. "You can win the case and still end up negative cash," said Zollars.

"By the time you pay the legal fees for tax court, you're already in five figures," he said. "You would've been better off paying the tax."

A rocky end to 2020

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Without clarity on forgiveness and deductibility, tax professionals will be wrangling with business owners' returns well after the year ends.

"The general stance I'm taking is that nobody will be forgiven on this in tax year 2020," said Adam Markowitz, enrolled agent at Howard L Markowitz PA CPA in Leesburg, Florida.

"It's my intention to extend every single corporate tax return for anyone who took PPP, and I will decide on a client-by-client basis what the tolerance will be," he said.

Guidance from lawmakers would also go a long way toward helping business owners see how their cash flow will look going into 2021.

"How much debt will I owe and how much will I owe in taxes?" said Sheneya Wilson, CPA and founder of Fola Financial in New York.  "It's important for a business to understand those numbers at year-end because it goes into planning for next year."