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Paycheck Protection Program QA

Question:  Is the PPP (Paycheck Protection Program) “forgiven loan” taxable to my business?

Answer: (answer from Mark Higley, Vice President of Regulatory Affairs, VGM Government)

To a degree, yes. But it’s likely to a much smaller extent than some businesses are estimating.  Recently the IRS released “Notice 20-32,” which confirms the loan forgiveness facet is deemed nontaxable, but the IRS indicates that certain “qualified expenses” paid with these funds will not be deductible. This effectively makes a portion of the PPP loan taxable. Let me explain in simpler terms and then use an example. The PPP provides forgivable loans to small businesses to help cover up to eight weeks of payroll costs, interest on mortgages, rent, and utilities. The total amount of the loan is calculated on 2.5 times of one-month worth of total payroll.  The SBA will forgive the portion of the loan that covers your first eight weeks of payroll, mortgage interest, rent, and utility payments. However, businesses must use 75% of the borrowed loan amount for payroll costs. Only 25% can be for mortgage interest, rent, and utilities. Assuming the business follows the requirements to retain or rehire its employees (see complete information here), and utilized 75% of the total loan for payroll related items. This portion is forgivable and non-taxable. But the “expense” portion – up to 25% of the total loan amount – is not deductible on the business’ income tax return, effectively making it taxable. The federal corporate tax rate is 21%. By way of example, if the company’s average monthly payroll was $10,000 and the business applied for the 2.5 times amount, then at least $20,000 had to be applied to the eight-week (two month) payroll. This $20,000 is forgivable and non-taxable. Assuming the remaining $5,000 is applied to the approved expenses (e.g., rent and utilities), the $5,000 cannot be included as a deduction in the company’s 2020 tax return. Effectively, the amount is (21% federal taxation rate * $5000) a $1,050 reduction in tax benefits. However, in the “bigger picture” this same company, in a non-pandemic relief scenario, would have incurred the same $5,000 of expenses – plus the $20,000 in payroll costs and none “forgiven” – and hence, with few exceptions, is a welcome benefit to small businesses.