Taxability of Government Program Payments
The Internal Revenue Code (“IRC”) defines gross income as all income from whatever source. “Gross Income” is typically taxable subject to normal application of the IRC. This year, with Covid-related government intervention, there is significant interest in understanding the tax implications of different elements of that aid.
There are currently several types of government assistance programs that may affect your tax position in 2020 and likely 2021.
Paycheck Protection Program (“PPP”)
On April 30, 2020, the Internal Revenue Service (“IRS”) released Notice 2020-32 (“notice”) providing guidance regarding the deductibility of expenses paid with the proceeds from PPP loans. The IRS correctly acknowledges that the amount forgiven under the PPP is excluded from gross income via section 1106(i) of the CARES Act. However, the IRS argues in the notice that expenses paid with PPP funds that are forgiven are non deductible.
The IRS has not provided enough guidance for tax professionals to have a clear picture of the tax implications in 2020 and 2021. For example, if the PPP loan is forgiven in 2021, would the expenses associated with forgiveness be non-deductible in 2021 when forgiven or in 2020 when the expenses were paid? We expect the IRS to provide guidance before year-end.
It appears to be broadly accepted that Congressional intent was forgiven PPP loans were not to be treated as taxable income and that the expenses associated with forgiveness would be deductible. In addition, many tax professionals and professional organizations disagree with the reasoning used in the notice and the end result of expenses associated with forgiven PPP loans being non-deductible.
If the IRS notice is followed, Congress’ intent on helping put dollars back into businesses is severely compromised. Businesses benefit from having the loan forgiven, but take a hit when they face a much larger tax bill than they would otherwise have by not being able to deduct certain standard operating expenses. A business with a $100,000 PPP loan that was fully forgiven and a 20% tax rate will face a tax bill $20,000 larger than they would have if these expenses were deductible.
It is advisable to discuss the notice with your tax professional or trusted advisor.
Economic Injury Disaster Loan (“EIDL”)
EIDL loans are non-taxable. EIDL Loans are bonafide loans, with formal terms and no opportunity for forgiveness.
Economic Injury Disaster Loan Advance (“EIDL Advance”)
EIDL Advance funds are considered to be a grant and not subject to repayment. The forgiveness of these funds is automatic. The current tax treatment for the grant is to report as taxable income on the tax return.
EIDL Advance funds are not forgivable if the business also received a PPP loan. In cases where a business received both a PPP loan and an EIDL Advance, the EIDL Advance turns into a business loan utilizing the terms of the PPP program. In this case, the EIDL Advance would be considered a loan and not taxable income.
State & Local Programs
Many States, Counties, and Localities have developed programs to help small businesses residing in their jurisdictions. In most cases payments from States, Counties, and Localities are considered to be grants and included as taxable income on the tax return. It is advisable to discuss these payments with your tax professional as it may be possible for certain business types to avoid taxation (e.g. Corporations may be able to treat these payments as capital contributions under IRC 118 and avoid taxation).