Paycheck Protection Program (PPP) loan forgiveness and its tax and financial reporting implications are steeped in uncertainty. The key challenges are the timing of income recognition and deductibility of expenses, among other tax and reporting questions.

There are still a couple of issues pending with IRS and Congress regarding any taxation related to the PPP. And then there is the treatment for financial reporting purposes under GAAP that need to be considered.

The forgiveness of the PPP loan is not considered taxable income under the CARES Act. The IRS, however, stated in April that it is their interpretation (IRS Notice 2020-32) that any expenses paid by proceeds of the forgiven loan would not be deductible. So in a backhanded way, the forgiveness of the loan becomes a taxable event. No further guidance has been provided by the IRS as to the timing of the taxation on the non-deductible expenses, especially when the payment of the expenses are in one tax year and the forgiveness will likely be in another tax year. It is our position that if the IRS interpretation is upheld, the non-deductible expenses will be treated as a 2020 tax event, regardless of when forgiveness is granted. However, this does provide a planning opportunity as to when the event is taxable. If the loan is not forgiven until 2021 and the 2020 tax return treats the expenses as deductible until the loan forgiveness is granted, then there could be a case to be made that the adjustment to the income could be taken either in 2020 by amendment or 2021 with the original filing. The taxpayer selects the year that has the better tax outcome.

Tax experts had come forth and stated that the IRS has misinterpreted the law and that this position will be challenged in tax court if the IRS maintains this interpretation of the law, or if Congress does not act to counter the IRS position.

At the time of the IRS announcement, Congress made a statement that this IRS position was not the intent of the PPP program and they would correct this matter. If Congress acts to counter the IRS position on deduction of the expenses, then the reporting for tax purposes will be a moot point. Expenses will be deductible when paid, and the forgiveness will not be taxable income. Congress has taken no action at this time.

Hopefully, there will be some resolution on this matter prior to the filing date of the tax return. In the meantime, we are preparing tax projections for some of our PPP business clients with and without the expenses being deducted.

For accounting purposes, the PPP funding is typically recognized as a loan until forgiveness action is approved. The expenses paid with the loan proceeds will be recognized in the year accrued, and the loan forgiveness will be recognized as income in the year forgiven. If the PPP loan is not forgiven before the end of 2020, the additional debt on the balance sheet may impact financial ratios and covenants related to other lending agreements. The current lending covenants need to be considered and a discussion with the lender should be held to determine how the lender is treating the PPP funding in relation to the lending covenants.