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PPP loans and deductible employer plan contributions

“My client received a Payroll Protection Program (PPP) loan for his small business to help cover payroll expenses. He maintains a safe harbor 401(k) plan, and each year my client makes an annual lump sum contribution to the plan. The company will make its 2019 contribution in 2020, and the timing will be such that the contribution will be after the business received the PPP funds and during the 8-week loan forgiveness period. Can the business use some of the PPP loan to make the contribution and deduct the full amount of the 401(k) employer safe harbor contribution?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Massachusetts is representative of a common inquiry related to the PPP loan.

Highlights of the Discussion

This question can only be fully answered by your client’s tax professional and/or CPA.  The following response provides some general information on the topic based on the guidance issued to date. It’s for informational purposes only and cannot be relied upon as tax advice.

As it stands now, the IRS appears to take the position (in Notice 2020-32) that if a business uses the PPP loan for eligible expenses that would otherwise be deductible, the business cannot also take the tax deduction. That would be double dipping because the PPP loan, once forgiven, is not taxable income to the business. Consequently, that would mean if a business uses PPP funds to make employer contributions to a retirement plan as an eligible expense, and the PPP loan is forgiven, the business could not also deduct the employer contributions under Internal Revenue Code Sec. 404. Please see page 6-7 of Notice 2020-32 for a formal discussion.

There are some policy makers in Congress (e.g., Senate Finance Committee Chair Chuck Grassley, R-Iowa and House, Ways and Means Committee Chair Richard E. Neal, D-Mass) who are seeking to make changes to the IRS’s apparent stance on this tax issue. Therefore, it is important to watch for additional updates on this ever-evolving question of deductibility, and seek competent tax advice.

Conclusion

The various forms of Covid-19 relief granted to businesses and individuals come with myriad questions. Patience will be needed as answers trickle in, as well as the services of tax experts.

 

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De-villainizing Backdoor Roth IRAs

“Backdoor Roth IRAs sound bad. Are they?”  

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from California is representative of a common inquiry related to Roth IRA conversions.

Highlights of the Discussion

You won’t find the phrase backdoor Roth IRA in the Internal Revenue Code or Treasury regulations. Nor is it a specific product, but the industry has known about the phenomena for years.  A backdoor Roth IRA is merely a series of transactions or steps an individual can take to have a Roth IRA—regardless of income level.

The ability to make a 2019 Roth IRA contribution is phased out and eliminated for single tax filers with income between $122,000-$137,000; and for joint tax filers with income between $193,000-$203,000. Consequently, if a person earns too much, he or she cannot make a Roth IRA contribution directly (i.e., through the front door). But, many can still take another route—through a traditional IRA.

For traditional IRA contributions, there are modified adjusted gross income (MAGI) thresholds that apply above which individuals are prevented from making deductible contributions.[1] However, anyone under the age of 70½ with earned income can make a nondeductible contribution to a traditional IRA, regardless of income level.  Anyone with a traditional IRA can convert it to a Roth IRA regardless of income level. The traditional-IRA-to-Roth-IRA conversion is another route to having a Roth IRA—what has become known as the backdoor Roth.

IRA technicians through the years have raised the specter of the Step Transaction Doctrine to cast a shadow over the efficacy of the backdoor Roth IRA. The Step Transaction Doctrine is a broad application tax law policy in which the IRS may view a series of separate but related transactions as a single transaction and apply any tax liability based on that transaction rather than the individual transactions in the series.

A traditional-IRA-to-Roth-IRA conversion is a taxable event to the extent a person converts pre-tax dollars. There are ways to maximize the tax efficiency of the transaction, for example, by rolling over IRA pre-tax dollars first to a qualified retirement plan. Those strategies are beyond the scope of this writing, but the consultants at RLC’s Resource Desk would be happy to have those discussions.

Informal guidance from the IRS and Congress from a year ago seems to have put to rest the concerns about backdoor Roth IRAs and the Step Transaction Doctrine. First, Congress made reference to the legitimacy of the traditional-IRA-to-Roth-IRA conversion in its conference report for the Tax Cut and Jobs Act (see page 289).

Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.

Second, in a July 10, 2018, Tax Talk Today, Donald Kieffer Jr., a tax law specialist in employee plans rulings and agreements with the IRS Tax-Exempt and Government Entities Division, said the backdoor Roth is allowed under the law. Mr. Kieffer stated: “I think the IRS’s only caution would be whenever we see words like ‘backdoor’ or ‘workaround’ or other step transactions that are putatively enabling a way to get around limits – especially statutory contribution limits – you generally find the IRS is not happy and prepared to challenge those. But in this one that we’re talking about, it’s allowed under the law.”

Conclusion

According to IRS and Congressional guidance, “backdoor” is no longer a cue for a potentially illicit tax activity when linked to Roth IRA. Therefore, it’s time to de-villainize the transaction.

[1] If filing a joint return and covered by a workplace retirement plan $103,000,-$123,000; Single or head of household $64,000-$74,000; and Joint return with spouse not covered by a workplace plan $193,000-$203,000

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