“Taxes are the life blood of the government.” Well that is true and here is an example. On April 30, 2020 the IRS issued Notice 2020-32 (“Notice”) https://www.irs.gov/pub/irs-drop/n-20-32.pdf . The Notice states that although forgiveness of a PPP loan is not deemed taxable income, the payment of wages and other qualified expenses using the PPP loan are not deductible expenses to the borrower/business. The Treasury Department calls the Notice, a “clarification.” Reports state that Congress is not pleased with the Treasury Department’s decision, and corrective legislation may be introduced to correct the IRS’ interpretation of the Notice.
The tax effect of the “clarification” to a business is that the value of a PPP loan is reduced in an amount equal to the business’ applicable tax rate. For instance, a small day care provider employs three people full time but has had to close its doors and furlough them because of Covid-19. The owner applied for and received a PPP loan from the Small Business Administration in the amount of $25,000 to pay employee wages for the next three months. The business owner is keeping the employees paid, albeit they are not actually working, but the loan is forgivable. However, the actual tax effect is surprising. If the business remained closed for the three-month duration, there would be no negative tax effect to the business owner.
Now suppose the state re-opens for business, subsequently the day care center also re-opens, the employees go back to work, and the business brings in operating income. How is taxable net income determined? As stated above, the PPP loan will not be includible in net income if used for wages, good so far. But the Notice states that the payment of wages using a PPP loan is not deductible against business income. This means that the business’ net income will of course be greater than usual and as such, the business owner will likely owe more taxes. Although it may sound reasonable, there is no tax deduction for wages paid with PPP loan monies. The negative effect of the IRS’ position is to mitigate the positive impact of PPP loans by applying a back-end tax on the PPP loan. The result of the IRS’ position is that the PPP loan monies will be taxable to the business owner on money he or she never saw.
Just wondering, surely Congress did not intend to incentivize businesses with PPP loans to close their doors in order to avoid paying taxes on money they never made.