In the wake of the COVID-19 pandemic, the federal government enacted several stimulus initiatives including the Paycheck Protection Program (“PPP”) within the CARES Act. The PPP allowed small and mid-sized businesses to receive a loan, with the ability to be forgiven if used according to loan guidelines, of up to two and a half times their average monthly payroll.
While many businesses successfully participated in the program, the tax ramifications of receiving a PPP loan have been somewhat unclear. On April 30, 2020, the IRS released Notice 2020-32 (“the Notice”) regarding the income inclusion for cancelation of debt and also the deductibility of certain expenses related to the PPP. The Notice states income associated with loan forgiveness, as a result of the PPP, will be excluded from gross income. However, the Notice also provides that no federal income tax deduction will be allowed for expenses covered by a forgiven loan.
PPP’s Impact to Qualified Research Expenditures and the R&D Credit
The R&D tax credit is generated by Qualified Research Expenditures (“QREs”) as defined by Internal Revenue Code Section 41(d)(1) and includes costs such as wages, supplies and contracted research. It is important to note that given the guidance provided in the Notice, a taxpayer will not be able to claim QREs that are also expenses forgiven under the PPP. Generally, most R&D credit claims are largely driven from wage based QREs.
It is also important to know that when applying for loan forgiveness, there is no requirement that dictates how the PPP loan funds must be allocated amongst departments in your organization. This allows for taxpayers to use their discretion when applying the loan funds to costs that may not impact or diminish the R&D credit claim. For example, by applying the forgivable loan proceeds to sales and marketing or administration departments or to non-payroll costs, a taxpayer can lessen the effect to the R&D credit and thereby maximize tax savings.
Congressional policy officials voiced their concerns of how the IRS has interpreted these issues of non-deductibility surrounding PPP loan forgiveness in a letter directed at Treasury Secretary Mnuchin. Bipartisan support remains and language has been drafted for a legislative fix that would override the IRS ruling and allow the tax benefit intended by Congress for small businesses that received a PPP loan. However, until such guidance is made official, considering when and how to apply for loan forgiveness will be very important to maximizing your R&D tax credit.
Navigating the PPP loan application and understanding tax implications is complex. Thankfully, BPM's specialists are available to help. To learn more, contact Brett Hazlett, Advisory Director at [email protected] or Andre Shevchuck, Specialized Tax Services Practice Leader, at [email protected].
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