Updated Dec 28, 2020
Officially signed into law on December 27th, the recent omnibus Covid-19 relief bill H.R. 133 reversed the Service’s previous stance regarding the deductibility of PPP-related expenditures. Among the bill’s voluminous provisions, section 276 (beginning on page 2004) makes clear that no deduction shall be denied as a result of a PPP loan’s forgiveness. Consequently, a taxpayer’s potential federal research credit will be unaffected as a result of the taxpayer’s utilization of a PPP loan and subsequent loan forgiveness. This protection is extended both to loans under the original Paycheck Protection Program as well as future loans to be granted under the bill’s expanded program.
While the enactment of these provisions provide urgently needed relief to companies utilizing the program federally, it remains to be seen whether state relief programs will follow suit. For example, as of this writing California remains committed under Assembly Bill 1557 to disallowing deductions and credits based on PPP-related expenditures. CTI will continue to closely monitor the progress of potential future state or federal Covid-19 relief packages and provide updates on each’s impact to PPP loan expense deductibility and the R&D credit as they evolve.
Published Dec 8, 2020
Due to the Coronavirus pandemic, 2020 has been a whirlwind of change and adaptation to a “new normal.” People and businesses witnessed change in all aspects of their everyday lives due to a slowing economy and an uncertain future. In order to aid this adaptation and change, Congress passed the Coronavirus Aid, Relief and Economic Security Act (CARES Act) in March of 2020. With the passage of the CARES Act came some relief for small businesses in the form of the Paycheck Protection Program (“PPP”) loans regulated by the Small Business Administration (SBA).
PPP loans are strictly for small businesses, as defined by the SBA. The PPP loan is entirely forgivable if the funds are used for eligible payroll costs, payments on mortgages, rent, or utilities during the 8-week period after borrowers receive funds. PPP loans dictate that at least 60% of the funds received must be used on payroll costs for the entire loan to be forgivable. However, the PPP does not specify that an equal amount of funds be allocated to all employees evenly. It is left up to the business on how to allocate loan funds received. Borrowers can apply for forgiveness once all loan funds have been used. Payroll and non-payroll documentation are required to be submitted for loan forgiveness.
Under the CARES Act, the PPP forgiveness was to be “excluded from gross income.” However, in Notice 2020-32, the IRS determined that “no deduction is allowed… for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan… and the income associated with the forgiveness is excluded from gross income…” In short, the PPP proceeds that were used for otherwise allowable business expenses will not be deductible. The Service reiterated this position in Revenue Procedure 2020-51, in which it provided a “safe harbor” for the deduction of these expenses, but only if the loan is not forgiven or if the taxpayer otherwise decides not to pursue forgiveness of the loan.
Shortly after the notice was released, members of Congress began pushing back. These members composed a letter to Secretary of the Treasury, Steven Mnuchin, for reconsideration in his determination—arguing that the determination was against congressional intent when the PPP was written into the CARES Act. Tax professionals are hopeful that the determination will change or alternatively that Congress will provide legislative relief. However, taxpayers must be aware of the potential tax implications of the current rule as it stands.
Impact on the R&D Tax Credit
The R&D tax credit is expense based and largely driven by qualifying wages. For many businesses, the largest Qualified Research Expenses (QREs) incurred and claimed correspond to the wages paid to employees for time spent conducting qualified R&D activities. In addition to the likely reduction in business activity brought about by the pandemic, for many businesses who have taken advantage of the PPP loan, the R&D credit for 2020 could be further reduced under the Service’s current interpretation. Under section 41, QREs are expenses that would otherwise be deductible during the tax year. Consequently, under the current determination of PPP funds a taxpayer will not be eligible to include PPP forgiven funds in its qualified expenses.
Although many tax professionals remain optimistic that the IRS will reconsider its determination, CTI professionals are fully prepared to assist its clients to maximize R&D tax credits for 2020 in light of these changes. If you are claiming the R&D Tax Credit, contact CTI today to help you navigate the potential complexities associated with the PPP and the 2020 R&D Tax Credit.
For more information or other tax questions, please consult a tax specialist.