Neilley & Co. CPA Blog

IRS Refund Alert!

 

Recently we’ve started hearing stories of a few taxpayers, both individuals and businesses, receiving IRS tax refund checks unexpectedly.  Often the amounts are unusually large, and sometimes the payee name doesn’t even match what was used on the tax return (eg, filing as “Robert” but the check is made out to “Bob”).  We haven’t heard yet whether the checks are fake, or something went haywire in the IRS system to generate them.  In any event, if you receive such a check, do NOT deposit it unless you can get positive confirmation that the refund is actually correct.  Contact us or the IRS to get clarification, and if it was in fact issued erroneously, IRS will provide instructions about how to return it.

This article was written on November 23, 2020.  Be sure to check for more developments as time passes.

Congress passed the CARES Act last spring, creating the PPP loan program and criteria for loan forgiveness.  The Act specifically provided that any forgiven principal would not result in taxable income, which is usually the case with forgiveness of debt (the most notable exception being in cases of insolvency).  Early on however, IRS issued guidance that expenses paid with tax-exempt income (specifically, PPP loan forgiveness) are not deductible, which pretty much gets to the same result of increased taxable income.

IRS’ position led many advisors to recommend that borrowers drag their feet in applying for forgiveness, with the thought that if none of the loan is actually forgiven in 2020, all 2020 expenses should be deductible.  That defers the problem to next year, but in the process buys some time for Congress to intervene.  Apparently IRS got wind this was becoming a common recommendation, and last week they issued further guidance doubling down on their position.  Now their position is that to the extent a borrower “reasonably expects” loan forgiveness, the related expenses aren’t deductible in 2020 even if forgiveness isn’t finalized until 2021.

In our view, IRS isn’t really picking a fight with Congress, they’re just following long-established law.  In their rush to pass the CARES Act however, Congress didn’t dot all the i’s and cross all the t’s.  Ever since IRS pointed this out last spring, we have expected Congress to pass additional legislation to ensure their original intent is carried out.  Unfortunately, to date that hasn’t happened, and in the current political environment, it’s hard to predict if it ever will, or if it does, when.   Maybe they’ll let things stand as is and try to put IRS in the role of bad guy when borrowers owe tax due to forgiveness.  Maybe they’ll get around to it next spring and make changes retroactively.  Maybe they’ll address the issue but put more qualifiers on it to “weed out” companies they don’t think “deserve” the tax windfall of loan forgiveness and full expense deductions.  Especially if it isn’t resolved by the time Congress closes their session this year, who knows what this might look like?

We don’t think we’ve heard the final word on this issue.  For now, we recommend planning as if the IRS position will hold as the worst case scenario, and assume expenses related to forgiven PPP loan proceeds won’t be deductible.  If that is later overturned or modified, then PPP borrowers will be that much better off.  In the meantime, we suggest extending affected 2020 returns until the dust finally settles to avoid having to amend later if things change.

 

Although the current scenario is fraught with uncertainty, there are still important strategy decisions to maximize PPP loan forgiveness, and planning opportunities in light of it.  There is an old saying that when times are good, you need a good advisor; when times are bad, you REALLY need a good advisor.  If you could use some help to navigate your way through these uncertain times, we would be happy to have a conversation.  Feel free to get in touch to schedule a phone appointment with one of our business or tax advisors.

In August, President Trump signed an Executive Order to defer withholding and deposit of the employee’s share of Social Security tax, starting September 1^st and continuing through December 31^st.  The order does not affect income or Medicare tax withholding, nor the employer’s share of Social Security, just the half that is normally withheld from employees’ pay.

The idea behind the deferral was to give employees a temporary boost in their take home pay.  On the surface it sounds all well and good, but beware, landmines abound.

First, the deferral only applies if wages are less than $4,000 for a bi-weekly payroll period, or the equivalent amount for other pay periods (for example, $2,000 for weekly payroll).  Therefore, the deferral might apply to some employees and not others.  In addition, for any one employee, the deferral might apply to some pay periods but not others.  For example, if an employee gets a bonus or commission check, that particular pay period may exceed the wage limit and not qualify for a deferral, even though other pay periods might.  That could lead to a roller-coaster of withholding for the remainder of the year.

It is important to be aware the employee’s share of Social Security tax is delayed, not waived.  The employer will be required to collect the delayed tax through extra withholding during the first quarter of 2021, above and beyond the normal withholding which will resume at that time.  If an employee leaves before the shortfall is made up, the employer must withhold the balance in a lump sum from their final check or make other collection arrangements.

Payroll software will take time to reprogram for this anomaly, and it’s possible some systems may even choose not to.  We’re also concerned whether IRS can successfully reprogram their systems in time to reflect this allowance for third quarter payroll filings due in October, which includes September payroll.  Any hiccups on their end could lead to all sorts of notices and headaches through no fault of the employer.

Even under the best of scenarios, this deferral represents a significant disruption to the normal flow of payroll withholding, reporting and tax deposits, which could lead to confusion and a myriad of problems for both employers and employees alike.

It appears the deferral is optional, not mandatory.  It also appears deferring the withholding is solely the employer’s call, and an employee can’t force the withholding to be delayed if the employer doesn’t want to participate.  If an employer wants to skip the hassle and continue withholding as usual however, it may require some well-crafted communication to employees to make the case that it’s in their best interests as well, or at the very least, not a disadvantage.  Remember, this is a timing issue of when the tax will be withheld and deposited, not a tax cut or windfall that employees might miss out on if employers take a pass.

We advise business owners on a wide range of tax planning, accounting and business management issues.  If you would like to explore how we could help you move your business forward, please call for a free, no-obligation appointment.  614-418-1775