PPP Loan Forgiveness and Maine Tax Considerations for Tax Exempt Organizations
The Paycheck Protection Program (PPP) program under the CARES Act states that the forgiveness of the PPP loans will not be taxable income. However, shortly after the CARES Act passed, the IRS announced that they would not allow tax deductions for business expenses paid with PPP loan proceeds that were forgiven.
In addition, Maine has not yet passed legislation that specifically states that Maine will follow federal law regarding the CARES Act. As the law currently stands, if Maine does not follow federal law, many businesses will have a difference in their state and federal taxable income in 2020 and 2021.
Thus, there is some concern whether the difference between Maine and federal law will affect tax-exempt corporations in Maine.
Unrelated Business and Cancellation of Debt Income
Tax exempt organizations generally do not owe income tax unless they have “unrelated business income” (UBI). UBI is income generated by a tax-exempt organization from an unrelated trade or business that is regularly carried on. The question for Maine nonprofits is whether “cancellation of debt income” is UBI, which is a question with some grey area. Generally, it is possible to argue that cancellation of debt is UBI, but only in situations where the loan proceeds are used primarily for the organization’s unrelated business.
Cancellation of debt income is generally taxable income because that taxpayer benefitted from the forgiveness of a debt. For example:
A business defaults on a business loan and the lender determines that the business will not be able to pay the entire loan back and collection efforts will be futile. In which case, the lender forgives some or all the remaining loan. Thus, the business benefits from loan proceeds that they did not have to pay back, and they may have cancellation of debt income.
For cancellation of debt income to be UBI, the loan forgiveness would have to be in connection to an unrelated business that is regularly carried on. Arguably, this could occur if a tax-exempt organization used loan proceeds in its unrelated trade or business, and that loan was later forgiven.
From the perspective of the PPP loans, if a tax-exempt organization with an unrelated business used the PPP proceeds to pay for salary and expenses that were being used to generate UBI, then it is arguable that a portion of the loan forgiveness could be cancellation of debt income and UBI that is taxable in Maine. However, if the tax exempt organization does not usually have UBI or if the PPP proceeds were not used in the unrelated business then the cancellation of the PPP loan would not be UBI, and there would not be taxable income in Maine.
Moreover, for PPP loan proceeds to be forgiven, they must be spent on employee wages, rent, utilities, or other specified business expenses. All these business expenses are tax deductible. In the uncommon circumstance that Maine argues that a tax exempt organization’s PPP loan proceeds are connected to UBI then the organization would be able to deduct the expenses that the PPP loan was allocated towards in connection to the organization’s unrelated business. As a result, in the event Maine law requires that some or all of a tax-exempt organization’s PPP loan forgiveness is taxable in Maine, all of the loan proceeds would have been used to pay tax deductible business expenses, which would mitigate or negate any income tax consequences.
If Maine does not pass a law that will require Maine tax laws to follow the federal CARES Act, there is concern that businesses will have to pay Maine income tax on the PPP loan forgiveness. However, most if not all Maine tax exempt organizations Maine tax consequences will not be significantly impacted by PPP loan forgiveness. In the limited circumstance where an organization’s PPP loan proceeds were used in the organization’s unrelated business then there is an argument that a portion of the loan proceeds could be subject to Maine income tax, but the tax would be mitigated by the applicable tax deductions.
About the Author
Andrew Wells, JD, LLM is an Associate at Bernstein Shur and is passionate about helping organizations find balanced conclusions grounded in tax law and translating complex tax issues for clients with a variety of backgrounds.
Disclaimer: This article has been prepared and made available by Andrew Wells for informational purposes only. This article does not constitute legal advice on any matter, nor does receipt of the article create an attorney-client relationship with Mr. Wells or Bernstein Shur. No recipient of this article should act or refrain from acting on the basis of any information in this article without seeking legal advice on the particular facts and circumstances at issue from an attorney licensed in the recipient’s state.