The IRS provided additional rules for PPP loan tax return preparation this week.
In this short post, therefore, I want to review what we now know about how tax returns handle PPP loan transactions.
Then, I’ll share my thinking about how we report this PPP loan activity on tax returns. But let’s start with the statutes and then the administrative guidance.
Two Statutes Matter: Section 1106 and Section 265
Congress wrote two laws that set the stage for how PPP loan tax returns work.
Everybody paying attention to paycheck protection program loans knows about one of those statutes, Section 1106 of the CARES act. It said forgiveness of the PPP loan didn’t count as taxable income.
A second statute, Section 265, many folks initially ignored (including me but let’s keep that under our hats.) It says amounts paid with nontaxable income don’t go on a tax return as a deductions.
Combine these two statutes and taxpayers end up with a common sense result: A taxpayer doesn’t pay income taxes on the PPP loan funds—even though usually cancellation of debt creates income.
But the expenses paid in effect by the Federal government through the PPP loan? Yeah, you didn’t actually pay those. So you don’t get the deduction.
In Notice 2020-32, the IRS patiently explained how the puzzle pieces fitted together here. And then at that point, some taxpayers, maybe most tax accountants, and even a few members of Congress began complaining.
Revenue Ruling 2020-27 and Revenue Procedure 2020-51
That complaining I mentioned? Hopes ran high that the Treasury and Internal Revenue Service would relent and give taxpayers an even bigger break. People not only wanted free money. They wanted tax deductions for spending that free money.
On November 18, 2020, the IRS published two new rules. And dashed hopes.
In Revenue Ruling 2020-27, the IRS said taxpayers do not get deductions for amounts paid with PPP loan proceeds if the taxpayer anticipates receiving forgiveness.
And then in Revenue Procedure 2020-51, the IRS dealt with the obvious real-life wrinkle: a taxpayer doesn’t receive PPP forgiveness. What Revenue Procedure 2020-51 says is this: If you don’t get forgiveness for some bit of PPP-loan spending or for some reason decide not to apply for forgiveness, you predictably do get to deduct.
The Revenue Procedure then outlines the various ways you can “get” the deduction onto a PPP loan tax return. The IRS basically allow the approaches you would guess.
You can deduct “unforgivable” 2020 spending on your original 2020 return. Or you can amend your 2020 return later on.
Alternatively, you can deduct on your 2020 spending on 2021 original return—or an amended 2021 return.
Finally, partners in a partnership can deduct using an administrative adjustment request (AAR) under section 6227.
What All This Means for PPP Loan Tax Returns?
Let me share my thoughts on the above. I’ve had a couple of days to process the new guidance and organize my thinking. But also, if you’re a tax practitioner or a PPP loan borrower, feel free to disagree or make other comments.
First, regarding the chatter from members of Congress who don’t like the way the accounting works? (I’m thinking, for example, of Senators Grassley and Wyden.) I say we ignore that. We can’t plan based on that chatter.
Note: If Congress really wanted to get the tax accounting result Grassley and Wyden want, it needed to rewrite Section 265. As those boys know. Or should know.
Second, taxpayers need to have prepared their PPP loan forgiveness application before the tax return can be prepared. The 3508 form becomes the source document required to determine the appropriate deductions on a PPP loan tax return. My thought is that taxpayers file their 2020 returns based on the 3508 form they complete, then. I don’t think they wait until they receive confirmation of the actual forgiveness amount.
Note: A lender gets 60 days to process the forgiveness application. The SBA gets 90 days to review the application.
Third, tax accountants need to plan that the PPP loan tax returns will require a bit more work. Using the information shown on the PPP loan forgiveness application, tax accountants will need to adjust deductions. Further, if a PPP loan tax return deducts amounts paid with unforgiven PPP loan proceeds, the tax return needs to include a safe harbor statement as per Revenue Procedure 2020-51. Tax accountants want to allow time for extra effort.
Note: Unless I hear otherwise, I’m thinking a single adjustment shown as a negative “other expenses” amount. For example, someone with a $50,000 PPP loan might report a ($50,000) negative expense.
Fourth and final, taxpayers facing uncertainty about PPP loan forgiveness should simply extend their tax return due dates. The tax accountants all know this intuitively, of course. But some taxpayers unaccustomed to extensions will need to be encouraged to extend until after they’ve finished their 3508 PPP loan forgiveness application. And maybe even until after they receive confirmation of the forgiven amount.
Other Resources
Preparing 3508S PPP Loan Forgiveness Application
PPP Loan Tax Accounting for Sole Proprietorships and Partnerships
For fun, CPAs may be interested in this blog post about one of the most profitable single owner CPA firms in the country: Small Business Compound Growth: The Long Game.
So, I agree with what you wrote but, I have a big question regarding restaurants. Since tips count as compensation for PPP loan forgiveness and tips are not generally an expense for a restaurant, if the restaurant allocates mostly tips for the compensation part of the PPP loan forgiveness, does that reduce the amount of expenses the restaurant is not allowed to deduct?
Hi Steve,
Your Note says,
Note: Unless I hear otherwise, I’m thinking a single adjustment shown as a negative “other expenses” amount. For example, someone with a $50,000 PPP loan might report a ($50,000) negative expense.
I think the proper procedure to record PPP loan is the following journal entries. We should not separate PPP loan expenses on the books and tax return because then payroll expenses will be different than form 941 and 940 and that can cause IRS audit.
When PPP loan is received:
Dr. Cash in Bank
Cr. Notes payable – Bank PPP
When the lender notifies PPP loan forgiveness :
Dr. Notes Payable – Bank PPP (to the amount of forgiveness)
Cr. Other income-Gain on debt Extinguishment (per AICPA)
Your result like Kelly Oakes returns the right number. But obviously AICPA doesn’t make the tax accounting rules. Congress does.
So I’m not sure how we thread this needle. Obviously Congress says the COD isn’t income.
Alternatively, couldn’t you report (anticipated) unforgiven PPP funds as “Other Income” and include the expenses paid by those funds on the appropriate expense lines rather than use a negative expense amount?
I think that works out to the same result. It seems a little funny to me. I guess because Section 1106 specifically says the COD isn’t income. But, yup, you’re exactly right about the essential nature of the tax accounting.
I understand your comment about just taking a lump-sum negative deduction to account for the PPP loan forgiveness. But I think it may be more complicated than that. For example, W-2 wages impact the §199A qualified business income deduction and the R&D tax credit calculations. If we are not allowed to deducted wages paid with forgiven PPP loans, will this impact these and other tax benefits based upon wages? If so, it seems that we would want to include the 40% non-compensation PPP eligible expenses in the forgiveness application rather than only listing wages as some banks are asking for, to simplify their loan review process.
So, you may know this, but I really fell down the rabbit hole on the Sectioj 199A stuff. No kidding, I read the proposed regulations and the final regulations multiple, multiple times. And I don’t read them to say 199A looks at wages on an 1120S or Schedule C or 1065. I read them to say 199A looks at wages reported on a W-2.
If that reading is right, 199A isn’t directly impacted by a lost of some portion of the wages deduction. Note, though, that a change in the taxable income (due to lost deductions) may impact 199A.
Regarding the R&D credit, I would think you use a similar approach. And I haven’t checked that. But does the R&D credit formula look at W-2 or 1120S? (If someone wants to look this up and comment, that’d be great. Otherwise I’ll try and do.)
What’s the journal entry for the “negative” expense?
I think you just “credit” the “Disallowed PPP expenses” account.
Hi Steven:
As always, you have an excellent approach on addressing tax legislation and you are a valuable asset to the tax community. SBA loan proceeds are non taxable so the forgiveness portion being non taxable makes this a non issue on the income side. I like your single adjustment approach. Most PPP advances under $50,000 should have no problem getting full forgiveness. Rather than having to deal with the various stages of submission, processing, and approval/denial, I agree that an extension is a good idea. I have decided that all my clients in PPP limbo will be given a temporary adjustment equal to the loan amount to create a worst case scenario on loss of forgiveness deductions. That way if tax owed needs to be paid with the extension, when the return is eventually filed there will be zero tax owed or a refund. It will also enable a reasonable way to provide estimated payment amounts which will need to be sent prior to filing on or before the extension due date.
I’m not overjoyed having a single expense for the PPP loan expenses – seems like it defeats the purpose of a P&L statement. Rather I plan to produce 2 sets of 2020 statements for clients who have or will qualify for full forgiveness. One will mirror the tax reporting requirements – no additional income for the loan forgiveness and no qualified PPP expenses deducted. The second statement will reflect one of your earlier posts – an income line item for the PPP loan forgiveness and all PPP expenses deducted in the proper categories. Both statements have the same bottom line net income. In my thinking, if a client is applying for loans or trying to sell a business, the second statement clearly defines all the business expenses and the PPP loan income line is identified to easily calculate business gross income.
When I advise clients buying or selling a business, I will certainly be aware of and make certain my client is aware of all the possible accounting nuances associated with 2020 PPP loans.
Thanks for your article. I do agree with all of the above, especially, as you wrote, “Unless I hear otherwise, I’m thinking a single adjustment shown as a negative “other expenses” amount. For example, someone with a $50,000 PPP loan might report a ($50,000) negative expense.
Fourth and final, taxpayers facing uncertainty about PPP loan forgiveness should simply extend their tax return due dates. The tax accountants all know this intuitively, of course. But some taxpayers unaccustomed to extensions will need to be encouraged to extend until after they’ve finished their 3508 PPP loan forgiveness application. And maybe even until after they receive confirmation of the forgiven amount.”
But I’m still concerned for Schedule C filers regarding whether or not to include PPP forgiveness amounts in income or not. I still think in terms of “replacement income,” which would be taxable. Any new thoughts on that?
Do you think that all payroll in 2020 , regardless of whether paid with PPP funds or not, still counts as “payroll” for the purpose of the calculation of the QBI deduction? Or does payroll paid from PPP funds get disregarded for QBI purposes? If a company spent far more during the covered period on payroll, rent, utilities, etc. than their PPP loan amount, would you consider a ratable amount as being allocated to payroll if, in fact, the payroll portion of PPP expenditures shouldn’t be included in the payroll factor for the QBI deduction?
The Section 199A formula looks at, basically, W-2 wages. Not at the wages reported on the income tax return. So I don’t think “losing” some of your income tax return wages deduction directly impacts your QBI deduction.
Where I think it will indirectly impact your 199A formula is taxable income. I.e., if your taxable income limits the 199A deduction, changes to the taxable income (such as because of lost deductions due to the PPP) will impact 199A.
Does that make sense? (I don’t mean “do you agree?”… I mean, do you understand what I’m thinking happens.)
So, how is a sole proprietor affected if the sole use of PPP funds was to pay the owner’s weekly draw? The profit of a sole proprietor qualified as wages for PPP funds, but there is no deduction for the owner’s draw.
Is the amount used for owner’s draw reported as income?
Is the PPP forgiven for the amount used to pay owner’s draws, and not included as income?
Any ideas on this?
I don’t think that draws paid to the sole proprietor count as taxable income.
More discussion here: https://evergreensmallbusiness.com/sole-proprietor-and-partnership-ppp-tax-rules/
We are a tiny 501(3)c non-profit that received a small PPP loan. Since we were to only use the money received for payroll, we considered it income and included the amount in our quarterly 941 tax return. We have received full forgiveness of the PPP from the SAB. So now what do we do about the total compensation amount of the 941, which included PPP funds? Was it wrong to include the funds received in the totals of our Quarterly?
No I think you did it right. The wages should have appeared on the 941.
What are your thoughts on whether Senate Bill 3812 will be passed and if it does pass, whether it will negate this?
I think you mean SB 3612… (Bill text here: https://www.congress.gov/bill/116th-congress/senate-bill/3612/text )
But I don’t think that’ll pass. First, I see significance in the fact that Congress already made one set of changes to the PPP in June and didn’t at that time include the text of the May 3612 bill. Second, I see significance in fact that they haven’t been able to pass additional legislation that extends the program.
BTW, I have a terrible track record of predicting what tax laws will actually pass. Maybe most people do.
Do you have an update on how you would structure the payments to partners in a partnership when this will be the basis for forgiveness. In your August article, you leaned toward calling them Guaranteed Payments, however I wasn’t clear if you were certain that this expense could still be taken since it was paid with PPP funds.
Do you have any new thought on this given the new guidance?
Good question Kevin. And what I’m still thinking is, we do want to have partnerships pay partners that “owner compensation replacement.” And I’m also still thinking guaranteed payments work.
For other readers, here’s the blog post referenced: https://evergreensmallbusiness.com/sole-proprietor-and-partnership-ppp-tax-rules/
I get a 1099 as an independent contractor doing some web design and marketing work. I got a PPP Loan for $17k. I am looking at the 3508S and trying to understand how I get Owner compensation relief. I got 17k deposited in my account from my bank. I went thru the typical monthly expenses, but have no ‘payments’ or draws to myself. I’m not understanding how the application works in my case.
Your sole proprietorship needs to pay Drew the proprietor. Those payments count as owner compensation.
BTW, you should be using the 3508S form. And you should, I would think, get full forgiveness.
Thank you for this article! If anyone knows how to help me, I would appreciate advice. I started my business in late 2019. Being a new business, I operated at a loss during 2019. In January and February of 2020, I started to see the fruits of my labors and I was doing very well. Then, Covid hit. When the PPP loan came out, I had not yet filed my taxes for 2019. I applied for PPP using Q4, 2019 and Q1, 2020 income. I showed paid invoices and such. They gave me the loan for $17,000 which was 2.5 times my salary to that point. Well, like so many of you, I found the virus decimated my ability to travel and conduct my consulting business. I took the $17K and I made 24 withdrawals from my bank account to myself (once weekly, on Fridays) so that I would have a record of me disbursing the funds as my weekly payroll. When the forms came out for forgiveness, it stated that I need to use my 2019 Scheule C for forgiveness! I was floored because that was never used to grant me the PPP. Again, I started the business in late 2019 and didn’t have the profit. I was rolling in 2020 and this virus crushed me. What can I do?
Can I get PPP forgiveness using some quarterly statements and not my 2019 Schedule C? Thank you in advance for any help. I am so worried now.
Will there be a reporting requirement for loan forgiveness of “owner compensation replacement” in the 2020 1040 return? It seems clear when using forgiven PPP loan money for rent or utilities but unclear for funds used for owner compensation of a sole proprietor.
I don’t think so. That’s really the point of this blog post.