Many businesses have suffered during this economic downturn caused by the coronavirus pandemic. You’ve read about them in the media. But what you don’t read about as often are the many other businesses around the country that haven’t suffered as much. It probably hasn’t been a very profitable year for those businesses, but they’ve kept things going.
Sure, they’ve faced enormous challenges. But throughout the past few months, they’ve managed to operate and keep their people employed. Maybe they’re one of the countless essential businesses that were allowed to stay open, or maybe they’ve managed to keep things going with their employees working remotely. Or maybe they were able to pivot to more online sales or retooled their operations to produce different products or continued to fill orders placed before the outbreak.
Many have also participated in the Paycheck Protection Program (PPP). Few would argue that the program, despite some hiccups, hasn’t been successful. As I write this, more than half a billion dollars in forgivable loans has been distributed to more than four million small businesses, providing much-needed funds not only for payroll but also for certain operating expenses. The money received under the program has been an enormous help for those business owners who are struggling to navigate in these very uncertain times.
But unfortunately, the same program that has provided so much help for small businesses has also created a potentially significant tax problem for those very same beneficiaries.
It has to do with the forgiveness of the loans. According to the IRS, a small business will not be taxed when a PPP loan is forgiven. That’s the good news. But the bad news is that the expenses used in the forgiveness calculation, which include payroll, health insurance, retirement contributions, rent, utilities and mortgage interest, are also not deductible. Why is that bad news?
Let’s suppose your business is one of those companies that have struggled this year with no growth but is still keeping things together. You had about $1 million in revenues in 2019 and – even though it’s been tough – you believe that the economy will continue its recovery and you will wind up doing the same level of business in 2020. Let’s also suppose that you received $300,000 of PPP money that helped pay for your employees and other expenses and you’re able to get full forgiveness for the loan. That forgiveness won’t be taxable. But because the $300,000 won’t be deductible, your profits will be $300,000 higher than last year. If you’ve only been paying in estimated taxes based on last year’s profits, you’re going to have a much bigger tax bill for 2020.
“It’s a significant issue that many businesses will face this year,” said Mitch Gerstein, a senior tax adviser at Isdaner and Company in Bala Cynwyd, Pennsylvania. “We’re advising our clients who fall into this category to prepare for this potential liability.”
While most of us were working hard to keep things steady, we were not paying as much attention as we should to this looming problem. Sure, we were making our estimated tax payments. But we’re assuming that because this year has been so difficult, our profits will likely be lower and, therefore, so will our tax bill. But that may not be the case.
Unfortunately, we’re not taking into account the non-deductibility of all those PPP expenses, and if you don’t take actions now, you could be in a cash crunch when your tax bill comes due.
But what kind of actions? Gerstein is advising his clients in this predicament to behave as if it’s a profitable year and look to defer income into next year and accelerate expenses into this year where possible. “Some of our clients are considering paying extra bonuses to their employees as well as making more contributions to their retirement plans,” he adds. He also recommends taking advantage of accelerated depreciation rules by purchasing equipment.
The American Institute of Certified Public Accountants (AICPA) has been lobbying Congress to allow the full deduction of forgivable PPP expenses, among other recommendations. Back in May a bipartisan group of lawmakers also introduced legislation to make these expenses deductible. Many are hoping the issue will be addressed in the forthcoming stimulus bill that’s expected in the next few weeks or in a future bill that tweaks the PPP. But as I write this, no action has been taken and some accounting experts are growing frustrated as the months tick by.
“Why waste the ink to say that for purposes of the code, the loan forgiveness is not includible in income, if the government will just take away deductions in the same amount?” Chris Hesse, CPA, chair of the AICPA Tax Executive Committee, said in a statement. “Denying deductions of expenses forgiven under the PPP program is contrary to Congress’s intent.”
Gene Marks is founder of The Marks Group, a small-business consulting firm. He frequently appears on CNBC, Fox Business and MSNBC.