This article appeared in the December 2020 issue of MiMfg Magazine. Read the full issue and find past issues online.

In August of 2020, the U. S. Internal Revenue Service (IRS) weighed in on the deductibility of the expenses used as the basis for a company’s Paycheck Protection Program (PPP) loan forgiveness application. Unfortunately for taxpayers, the IRS made the determination that any expenses claimed as part of a company’s PPP loan forgiveness application would not be deductible on their 2020 tax return. While this position appears to conflict with the original intent behind the PPP program, the IRS is not expected to change its guidance unless Congress makes a technical correction to address the tax treatment of these expenses.

As a result, business owners are being forced to determine whether the benefit of applying for loan forgiveness is justified by the potential tax implications. Under the current IRS guidance, if a taxpayer applies for forgiveness, their taxable income will increase by the value of the forgiven loan. The tax impact is compounded further for companies who claim the Research & Experimentation (R&E) tax credit.

The R&E tax credit is available for the development or improvement of products, processes, techniques, formulas, inventions or software and is a dollar-for-dollar credit against the taxpayer’s federal income tax liability. The credit is based on the taxpayer’s qualifying expenses in three areas: research wages, research supplies and contract research. In a normal year this means that companies can get a two-fold tax benefit from qualifying expenses — a deduction in the year the expense is paid and a credit against their taxes.

However, 2020 has proven to be anything but a normal year. As mentioned above, any wages claimed as part of company’s PPP loan forgiveness application are not deductible for tax purposes. Since these wages are no longer being deducted on the tax return, they are also not eligible to be included in the calculation of the R&E tax credit and will reduce the value of the credit being generated. So, not only will tax-payers who apply for PPP loan forgiveness see an increase in their taxable income but also a decrease in their R&E tax credits.

In most cases the benefit of receiving full forgiveness of the PPP loan outweighs any increase in taxable income or decrease in the R&E tax credit. These impacts do, however, underscore the importance of understanding all your options related to how loan forgiveness can be calculated.

Clayton & McKervey, P.C. is an MMA Premium Associate Member and has been an MMA member company since February 2018. Visit online: www.claytonmckervey.com.

About the Authors

Bryan Powrozek is a Senior Manager in Clayton & McKervey’s Industrial Automation practice, focused on Research & Experimentation Tax Credits. He may be reached at 248-208-8860 or bpowrozek@claytonmckervey.com.

 

Sarah Russell leads Clayton & McKervey’s tax department and is a leading international tax expert. She may be reached at 248-208-8860 or srussell@claytonmckervey.com.