IRS throws nasty curveball to small businesses
How would you feel if two weeks before the end of the year you still didn’t know how much of your personal income would be taxable or what rate you would be expected to pay? That is the challenge thousands of businesses are facing as we speak.
On March 27, the Coronavirus Aid, Relief, and Economic Security Act (CARES) was signed into law by President Trump. This $2.2 trillion stimulus package was passed with bipartisan support in the wake of the COVID-19 pandemic. Among other things, it attempted to help small businesses keep from laying off employees through its Paycheck Protection Program, which provided forgivable loans to businesses that kept their employees on the payroll during the shutdown.
Unlike a second relief bill that has continued to stall in Washington, Congress acted quickly to pass this bill shortly after the deadly virus came to our shores last winter. Perhaps too quickly in many ways.
The PPP, in particular, has proven to not be as well thought out as many would have liked. When it was first being rolled out, reports of confusion between banks tasked with executing these loans and the SBA tasked with approving them were widespread. As these loans began to be processed, many small businesses complained that banks were giving priority to large companies. Many of you may remember hearing about large corporations such as Ruth’s Chris Steakhouse and Shake Shack receiving millions, causing the program to run out of money prior to thousands of small businesses even getting their requests submitted.
Now a second crisis related to these loans has popped up. Initially the expectation of this program was to have all loans that met the requirements of the law forgiven by the end of 2020. However, that has not occurred, partially because of a lack of clarity from the SBA as to how banks should go about processing these forgiveness requests, and partially because in June Congress passed the Paycheck Protection Program Flexibility Act which extended the amount of time borrowers had to meet the requirements of the original law and extended the time businesses had to apply for forgiveness.
While many in Congress have stated their original intention when developing the program was to provide these funds tax-free to the businesses that received them, the IRS has declared that although these forgiven loans are not taxable, the payroll expenses they were used for will also not be tax deductible. The fact that most of these loans have yet to be forgiven has created severe ambiguity about whether the payroll expenses these loans were used to pay are deductible in 2020.
In late November the IRS declared that regardless of whether these loans are forgiven in 2020, expenses paid with PPP funds would not be deductible in 2020, as long as there was a reasonable expectation that the loan would be forgiven at some point in the future. In direct response to this IRS ruling, Senate Finance Committee Chairman Charles Grassley, R-Iowa, and the committee’s ranking Democrat, Sen. Ron Wyden, D-Ore., issued a joint statement encouraging the Treasury Department to reconsider its position on the deductibility of these expenses because it violated the spirit in which the law was passed.
While Congress has pledged to provide clarity regarding the deductibility of these expenses in additional stimulus legislation, as of now no bill has been passed, leaving thousands of small businesses mere weeks to try to figure out their end of year tax plan.
As we speak, many companies are contemplating additional spending to offset these non-deductible expenses. However if they do this, they risk showing huge losses in 2020 if Congress changes the law to make these original payroll expenses deductible, or even worse they risk these loans not being forgiven and being left with no cash flow to pay them back.
As potentially devastating as this issue is for many businesses it has yet to get any widespread media attention. Because of this, the public and even many business owners are not even aware of the potential tax liabilities that are looming. While I do believe at some point additional legislation will be written to fix this problem, I’m not convinced it will happen by the end of the year, and on Jan. 1 it’s too late for businesses to make changes.
To everyone reading this, I would encourage you to contact your congressperson and demand this issue be resolved promptly. Our small-business owners have already faced enough unexpected challenges in 2020 they shouldn’t be forced to face another one come tax season.
(Past performance is no guarantee of future results. The advice is general in nature and not intended for specific situations)
Luke Davis is the director of operations and compliance at Stewardship Capital in Independence.