So many businesses took out Payroll Protection Plan (PPP) loans that the program's first tranche maxed out in a few days. Many see this as the only way to save their small businesses. Now, the Internal Revenue Service says it wants a cut. 

Typically, wages are tax-deductible, but for those who use the forgivable portion of a PPP loan to pay employees, those wages will be fully taxable, according to a recent IRS ruling

That's a significant blow to small businesses. Kiplinger laid out what the actual costs will look like:

Let's say a small-business owner requests and receives $600,000 to cover payroll for the 10 weeks where he or she is covered by the PPP. If they can't deduct that amount as expenses, that means their federal tax burden clocks in at a rate of 37 percent.

That equates to a $222,000 increase in their taxable income. Meaning the effective tax-free benefit of the loan is $378,000, not the $600,000 intended by the law.

It's not a pretty picture for most businesses.

Congressional pushback

Congress didn't intend for this money to be taxed. They wanted to give small businesses a boost. Senate Finance Committee chairman Chuck Grassley (R-Iowa) introduced a bill that will clarify that the money from the PPP loans should be tax-deductible

Grassley says that taxing this money is the opposite of what Congress intended, and his legislation wants to fix it. He said in a statement:

When we developed and passed the Paycheck Protection Program, our intent was clearly to make sure small businesses had the liquidity and the help they needed to get through these difficult times. Unfortunately, Treasury and the IRS interpreted the law in a way that's preventing businesses from deducting expenses associated with PPP loans. That's just the opposite of what we intended and should be fixed. This bill will do just that.

Chances that this bill or a similar one being introduced in the House by representative Lizzie Fletcher (D-Texas) will pass are high, since it has support from both sides of the aisle and in both chambers.

A different interpretation

Not everyone agrees that the IRS plans to tax this money. Accountant Tracy Coenen says there is no need to panic. In a message to me, she said,

This guidance does not penalize business owners. It simply says that if a business does not include the loan forgiveness in gross income, then it can't deduct the related expenses either. In other words, the business doesn't get free money coming in AND also get a deduction that reduce their tax bill. This guidance ensures a business will be in a neutral tax position: no income is reported, and no expenses are reported, so no taxes are owed.

If Coenen is right, the congressional scramble is much ado about nothing. Regardless, watch the IRS and Congress closely and speak with your accountant about how best to structure your finances if you received a loan.