Using Depreciation to Control a Loan Forgiveness Tax Surprise
Bonus depreciation and Section 179 expense can be a valuable tool to help you manage your business' profit margin this year. Here are some thoughts to consider.
Many businesses struggling during the pandemic took out Small Business Association Payroll Protection Program loans (SBA PPP loans). The SBA's willingness to forgive these loans is now creating a potential tax obligation. This is because the expenses used to offset this loan can no longer be deducted from the business.
So the loan forgiveness could create an unexpected taxable event.
A possible solution
Instead of paying some of the loan back to cover the tax created by the loan forgiveness, consider investing some of the funds in necessary capital purchases. You could then use special depreciation rules to manage your tax obligation. This can be done by using:
- Bonus depreciation. For assets that you purchase during the current fiscal year, you can deduct 100% of an asset's cost using bonus depreciation. You can use this option to expense 100% of an asset's cost using bonus depreciation this year.
Note: This bonus depreciation is 100% in 2020 and 2021. After that the bonus depreciation amount phases out through 2025.
Section 179 depreciation. Section 179 depreciation works similarly to using bonus depreciation, as you can deduct 100% of an asset's cost that you purchase and place in service during the current year. You can deduct up to $1.04 million of qualified Section 179 purchases in 2020.
Whenever you use these special tax rules, you will lose the ability to take this depreciation for these capital purchases in future years, so some tax planning is required. But at least you will be able to use some of the forgiven loan proceeds to help your business, versus paying it back in the way of additional tax.
Even worse, recent IRS notices suggest the PPP loan forgiveness needs to be reflected in this year's tax return, so you have little time if you wish to take advantage of bonus depreciation and Section 179 this tax year. To consider this option, you will need to select qualified assets and ensure they are placed in service before the end of your tax year. But if used correctly, depreciation can be used to offset business income and lower your taxes. Please call if you want to discuss your situation.