COVID-19 has caused thousands of small businesses to shut across America, some partially and others permanently. The spring shutdowns delivered a gut punch to owners of businesses such as salons, daycare centers and tattoo parlors. Small businesses are the backbone of the U.S. economy, employing nearly half of the private sector workforce. Unfortunately, lockdown and work-from-home measures brought about by COVID-19 have disproportionately affected small businesses – particularly in the leisure and hospitality sectors. At the onset of the pandemic 140,104 were marked temporarily closed on Yelp.com, but by August that had fallen to 65,769. That drop, however, is not entirely driven by businesses reopening; instead, many have simply gone under. More than 97,966 businesses have permanently shut down during the pandemic, according to Yelp.com's Local Economic Impact Report.
But not all small businesses have been equally affected. According to a Federal Reserve Bank of New York report in August, the number of active Black small-business owners fell 41% from February through April (nearly twice the rate of non-Black-owned businesses), as many struggled to access the Paycheck Protection Program. The good news is that there is still more aid available for small business owners. Over $130 billion in unused funds to be exact. However, the political deadlock in Congress due to the aftermath of the election has stalled progress.
Meanwhile, the forgiveness portion for businesses who received loans through the PPP is coming due, and the most recent rulings are not providing comfort for small businesses who have usually claimed deductible expenses when filing for their annual tax returns. Traditionally, small businesses have survived by being able to write off deductible expenses when filing for their annual tax returns on expenses such as company equipment, employee benefits, insurance, rent, mortgage and utilities. Opinion on the new rulings has affected banks who still want more clarity on the process, while advocacy groups have requested complete forgiveness.
Understanding the United States Annual Tax Returns and Deductible Expenses
What makes the U.S. tax code so complex isn't the taxes themselves--it's the allowed deductions. There's a wide variety of deductions you can use to reduce the taxes you'll pay as your company grows. Most tax practitioners advise LLC owners to take advantage of them simply because the United States tax code was generally built to support those who decide to start a business due to the contribution you would be making to the growth of the economy as a job creator. Some of the more important tax deductions a growing business has been able to qualify for in the past include:
Business expenses. The most common expenses include advertising which would come in handy as a lot of small companies have spent thousands on online ads as their business model shifted online. Employee benefits such as insurance have traditionally counted as well in addition to legal and professional services like consulting, accounting, plumbing too, rent, office supplies and even memberships to business associations. All deductible and guaranteed to keep you in business.
The IRS also allows you to deduct actual business related expenses to the company vehicle you use such as gas, insurance, cleaning, leasing fees, routine maintenance, tires and even depreciation, as long as it is registered under your business. You can also deduct a portion of the cost of business equipment which would come in handy if you installed plexiglass for your customers safety. For many small business owners, the ability to write off significant amounts of operating costs and expenses spells the difference between staying afloat or going under financially.
What does the new ruling say
According to the US Treasury Department website - Revenue Ruling 2020-27 and Revenue Procedure 2020-51 clarify “the tax treatment of expenses where a Paycheck Protection Program (PPP) loan has not been forgiven by the end of the year the loan was received.” Under this new ruling, there are severe restrictions on deductible expenses. This is a major blow to small businesses that are just beginning to come out of the blizzard that Coronavirus has been to them. The latest ruling outlines a number of restrictions that small businesses owners will face if they attempt to deduct business expenses from their annual tax returns if those expenses were paid for with money from a PPP loan. It states that a small business which “applies for loan forgiveness in 2020 and reasonably expects that its loan will be forgiven... may not deduct otherwise deductible expenses paid for with PPP funds.” The same rule applies to small business owners that have not applied for a PPP loan in 2020 but plan to do so in 2021 and who expect that the loan will be forgiven.
Nearly all small business owners – especially brick and mortar stores that depend on physical presence to stay open - will be severely affected as most are expecting some level of forgiveness. After the PPP application process had begun, the IRS released Notice 2020-32 in May, which outlined that a small business that received a loan would not be able to deduct otherwise deductible expenses if paid with funds from a PPP loan that was later forgiven. The ruling stated that the rate of forgiveness applies to rent, utilities, mortgage payments and common payroll costs such as accounting and federal taxes. These may also include new expenses to the balance sheet that were not necessary before - but are essential now such as personal protective equipment, sanitizers and the requisite hygiene setup, web conferencing tools to stay connected, packaging and shipping costs to disseminate cargo, product and fulfil customer orders and many more.
There is a further major blow that reduces the rate of forgiveness for small business owners who reduced wages by over 25 percent for employees earning less than $100,000 per year. Most business owners reduced wages as sales drastically dropped in the initial stages of the pandemic. The entire reason why the PPP was promulgated into law was due to rising social tensions as many lost their jobs or had their hours reduced.
Effects of new ruling
The latest IRS ruling will further devastate many small businesses in the US that have been staring down closed storefronts and reduced sales for months. Varying lockdown measures across states, the shift to remote work and schooling completely upended certain sections of the small business economy. The World Economic Forum noted October 6 that “in the US as a whole, data suggests that nearly a quarter of all small businesses remain closed” either temporarily or permanently during the ongoing health crisis and that “many of these temporary closures are looking to be permanent.”
Gallup also reported that the average holiday spending budget for individual Americans is expected to drop by over 14 percent this year compared to 2019, to the lowest level since 2016. Furthermore, a study from market analysis and data firm Numerator found that the spending habits of the average Thanksgiving family likely changed this year. Although a healthy majority, 60%, planned to spend about the same amount of money this year as they did last year on Thanksgiving, more than one in three - 34% decided to spend less. This data will in one way or another hold up over the Christmas season. There are several reasons for this, but the main driver is, of course, the pandemic. Budgets are tighter, uncertainty is widespread, and out of either necessity or an abundance of caution, many households are cutting back.
The drop in spending will disproportionately affect small businesses, which lack the capital and resources to offset the projected sales dip even as Christmas draws closer and closer.
What small businesses can do to survive
American small-business owners moved quickly when COVID-19 started shuttering shops in March. Fine dining restaurants shifted to takeout. Book stores introduced curbside pickup. Jewellery stores started selling merchandise online and gyms are now offering virtual classes. To adapt, most small businesses have shifted to social media and focused on creating new products that are suitable for an online audience. Employees have learned new skills to support emerging business models. In order to give customers some level of comfort, small businesses have heavily invested in new safety measures. As we roll into 2021, small businesses need to look at every cost once more and cut back further while depending more on a stronger digital strategy that leverages contactless deliveries for example.
