The Stunning IRS Ruling That May Bankrupt Small Businesses That Took PPP Loans

The IRS just did something that stunned me. It pulled the rug out from under desperate small-business owners just as they were starting to get their feet under them.

It was about a month ago that I praised what I saw as one of the most comprehensive, beneficial acts of Congress in American history. With the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, I saw the federal government committing to what I committed to doing for my clients decades ago: help small businesses.

While not sold as a clear and free windfall, the drafters of CARES made it clear: Spend this money on the right things — like keeping your employees on the payroll — and keep your books in order, and any loans you receive under the program would be forgiven. It was a lifeline to small businesses when they needed it most. A way to defend them, and by virtue the U.S. economy, from mass extinction.

IRS Takes Action After-Hours

But now that lifeline is being yanked away. On April 30, late in the evening — when few people were likely paying attention — the IRS released guidance that essentially nullified much of the benefit of the Paycheck Protection Program (PPP) created under the CARES Act. It stated that those who receive PPP may not receive tax deductions for using those funds to pay expenses. That includes expenses like payroll and rent, the very point of the PPP.

Congress specifically drafted the legislation so that small businesses could receive PPP loans without having to count it as taxable income. That makes the IRS’ move all the more stupefying. And it could cost some small businesses on the brink more than they can afford.

How Much Could It Cost Businesses?

That cost isn’t theoretical. It’s actually fairly easy to quantify.

Let’s say a small-business owner requests and receives $600,000 to cover payroll for the 10 weeks where he or she is covered by the PPP. If they can’t deduct that amount as expenses, that means their federal tax burden clocks in at a rate of 37%.

That equates to a $222,000 increase in their taxable income. Meaning the effective tax-free benefit of the loan is $378,000, not the $600,000 intended by the law.

Why Some May Say Move Makes Sense

The IRS has one goal: to collect revenue, so maybe this move shouldn’t have surprised me. Your tax adviser might tell you that they actually saw this coming all along, and it’s just how the IRS works. After all, to prevent "double dipping," the law doesn't allow deductions for expenses that are otherwise exempt from tax.

Even though Congress didn't create an exception to this rule, lawmakers intended the expenses to be deductible to provide the greatest possible benefit for small businesses. And while this type of tax exemption is usually reserved for organizations like churches and the military, it makes sense to expand it in the midst of a pandemic where most of the businesses receiving the PPP aren’t able to operate or bring in income due to state or local orders.

What You Can Do about It

The only advice I can give to my clients is to push back. The truth is that your voice matters. We do not have to collectively lay down and just take whatever the IRS hands down. Call your senator, the Small Business Administration and local representatives. Call your local news station and tell them how this change is going to hurt your business.

I’ve made my career caring for my clients and sticking up for them. And right now, that includes contacting my own senator, which I did the moment I heard about this guidance from the IRS. If there’s enough collective pressure, the IRS will either back down, or Congress will pass legislation that explicitly puts PPP tax deductions into law. A bill has already been introduced in the Senate that would make it clear that small businesses can deduct expenses paid with a forgiven PPP loan. There's strong bipartisan support for the bill, so its eventual passage looks promising — but the Treasury Department opposed the legislation.

If our only option is to put pressure on the Treasury, then that’s what we’ll do. Thankfully, likely after receiving messages from frustrated and beaten down business owners, a bipartisan group of congressional leaders on May 5 sent a letter to Treasury Secretary Steve Mnuchin asking him to reverse course on this shortsighted rule change. The letter states it nearly perfectly:

“Providing assistance to small businesses, only to disallow their business deductions … reverses the benefit that Congress specifically granted by exempting PPP loan forgiveness from income.”

But it’s only a first step, and the urgency and scale of this moment demands more. For already battered small-business owners, it certainly feels easier to throw your hands up and surrender, but don’t. If you have anything left, use it to stand up and let your voice be heard. It’s not the advice you’d normally hear from your tax adviser, yet these times are anything but normal.