The guidance effectively states that the income tax effect will occur in the year in which forgiveness is reasonably foreseen. For most taxpayers, this will be the 2020 calendar year.
Technically, the income tax effect does not come from loan forgiveness. The CARES Act clearly states this is not income to the borrower but instead comes from the non-deductibility of the expenses used to qualify for the forgiveness. Notice 2020-32 explains the rationale for this non-deductibility and the departure from the congressional intent in the CARES Act.
The new guidance brings up several questions that require additional information from the IRS and the states.
- Reducing expenses will increase taxable income for the related trade or business—this is assuming the trade or business qualifies for the QBI Deduction (QBID). That being said, does this increased income also qualify as income on which to base the QBID?
- One of the limitations of the QBID is that it is limited to 50% of the wages from the trade or business. If wages are reduced as required by Notice 2020-32, do the wages still qualify for the 50% limitation? Notice 2018-64 states that qualifying wages are based on the amounts on Forms W-2 from the trade or business, which will not be affected by any reduction in those wages’ tax-deductibility. While these wages still seem to qualify for the 50% limitation, more guidance may be necessary for further clarification.
- If the income from the trade or business is subject to self-employment tax, does the effect of the non-deductibility of the expenses increase the self-employment tax?
- For these individuals, the PPP loans were based on their net income for 2019, not any specific expenses. Forgiveness is also based on the net income from 2019. In this instance, where the loan (or a portion of it) is not based on an expense, how does the taxpayer report the income tax effect of the forgiveness? Logic would indicate that the income related to PPP forgiveness would be an add-back to income, but guidance is needed regarding the proper treatment. Further guidance will also be required regarding self-employment tax on this forgiveness.
- The states which do not automatically conform to federal treatment need to provide guidance on how this PPP loan forgiveness will affect the state taxable income. For the states that do conform, the issues relating to QBI are relevant.
There are likely other questions relating to PPP loan forgiveness. The hope is that taxing authorities will provide this guidance in time for 2020 tax planning or by the tax filing season in 2021. For more information or assistance regarding PPP loan forgiveness for your business, be sure to contact your CRI tax advisor.