IRS PPP rules for partnerships remain unclear
Last month, the IRS answered a few lingering questions about the Paycheck Protection Program Loans.
Unfortunately, they left open an important question of which equity account is adjusted when an S corporation is the borrower.
Nonetheless, let’s stay positive. Most small businesses in the United States are operated through a flow-through entity form. This can include a partnership or an S.
PPP loans could be forgiven if the proceeds were used for purposes permitted by law. The allowable expenses were generally those which are currently deductible if paid out of the taxpayer’s own funds.
The law as originally enacted made it clear that no income would accrue to the borrower if a PPP loan was canceled. He did not say much else about the tax treatment of these loans.
For most of 2020, the IRS asserted that no deductions could be claimed for P3-funded expenses. This was for various reasons (the IRS offered three), but the IRS’s approach seemed difficult to reconcile with the advantage that Congress was trying to confer.
At the end of 2020, Congress corrected the law to make it clear that expenses funded by PPP could be deducted. He also said that the income exempt from the rebate would increase the borrower’s base in a flow-through entity.
Adjustment of the tax base may be necessary to deduct expenses for the year paid. Questions arose about the treatment when the expenses were paid one year and the loan was canceled the following year.
The ânormalâ tax law would not allow an increase in the base until the following year (the actual remitting year). This could result in the suspension of deductions for the first year due to a lack of base.
In the 2021-48 tax proceeding, the IRS said tax-exempt income that increases the base would be allowed three times. The taxpayer can choose.
First, when eligible expenses are paid or accrued. Second, when the borrower asks for a loan forgiveness. Third, when the loan remission is received.
For taxpayers who filed a return before the new guidelines, the IRS will allow adjustments on the amended returns. This includes changes to documents filed as a partnership, which are usually cumbersome.
If your business received a PPP loan in 2020 and has at least requested a forgiveness in 2020, your tax preparer may contact you regarding a possible amended return. Some preparers followed the IRS approach even before it was announced.
Partnerships are generally allowed to allocate income and deduction items by agreement of the partners. S corporations do not have this flexibility.
To be respected, partnership allocations must have an âeconomic effectâ. Treasury regulations have qualifying terms that can be included in the partnership agreement and ensure that the IRS will honor the award.
If the regulatory language is absent, the attribution must follow “the interest of each partner in the partnership”. This is called the “PIP” and is based on factors. The result can be subjective.
The “inside baseball” explanation for partnership allowances is that there is only one test. In other words, if the regulatory language is in the agreement, it simply means that the attribution follows the PIP.
There is not one test if you are proficient in the language and another (PIP) if you are not. It’s pretty well settled among partnership tax specialists, even if the regulations do not specify it.
In the 2021-49 tax proceeding, the IRS stated that expenses funded by PPP in a partnership must be allocated using the PIP test. This statement does not explicitly recognize the ability to rely on the right language in the agreement.
Nonetheless, unless the agreement was drafted to indulge in nonsense, the language of the agreement should follow the PIP. The tax-exempt income and the base adjustment are distributed in the same proportions as the deduction for expenses.
In limited cases, all or part of the expenditure financed by PPP may need to be capitalized for tax purposes. This means that there would be no current deduction.
Without current deduction, there is no pivot to link the allocation of exempt income to a previous deduction. Therefore, the IRS rule of procedure is to assume a “hypothetical” deduction for capitalized items.
The allocation of exempt income, and the adjustment of the base, then follows the hypothetical allocation of the deduction for capital expenditure.
Jim Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected]