05.05.2020 IRS Denies Deduction for Forgiven PPP Loan Amounts Used for Business Expenses
In Notice 2020-32, released April 30, the IRS determined that expenses paid using the proceeds of Paycheck Protection Program (PPP) loans (Covered Loans) are not deductible expenses for income tax purposes if those loans subsequently are forgiven.
Under the PPP, recipients of Covered Loans may use the proceeds to pay payroll costs, certain employee benefits, interest on mortgage obligations, rent, utilities and interest on other existing debt obligations. A covered Loan may be forgiven to the extent the proceeds are used to pay certain expenses in the eight weeks following the origination of the loan (Eligible Expenses). To further extend the benefits of the PPP, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides that any amounts that would otherwise be included in gross income of the recipient by reason of forgiveness of a Covered Loan shall be excluded from such gross income.
The CARES Act did not address the deductibility of Eligible Expenses. Eligible Expenses normally would be deductible as necessary trade or business expenses under Code section 162 or as interest expense under Code section 163, subject to any other limitations. However, the IRS, in its analysis of the Code in Notice 2020-32, noted that Code section 265(a)(1) disallows otherwise allowable deductions allocable to classes of income that are exempt from taxes, as well as interest on indebtedness incurred or continued that is exempt from taxes. As the CARES Act operates to exclude the amount of a forgiven Covered Loan from gross income, the Notice states that it results in a “class of exempt income” to which Eligible Expenses are allocable. Therefore, to “prevent a double tax benefit,” the IRS concluded that the Code disallows deductions of forgiven PPP loan amounts used for Eligible Expenses. It is important to note that the Notice will only disallow the deduction of amounts used for payment of Eligible Expenses up to the aggregate amount of PPP loans forgiven.
The Notice leaves any solution to the issue to legislative action. The heads of congressional tax committees have reacted quickly, expressing disappointment with the guidance of Notice 2020-32. Senate Finance Committee Chair Chuck Grassley (R-Iowa) was quoted as saying, “[T]he intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible, this notice is contrary to that intent.” The Chair of the House Ways and Means Committee Richard E. Neal (D-Mass) also said, “[W]e are planning to fix this in the next response legislation.” While taxpayers wait for Congress to provide a fix for the issue, in the meantime they will need to consider the impact of the Notice on their modelling and strategic decisions.
Those seeking the notice in full can find it here.
Please note: This alert contains general, condensed summaries of actual legal matters, statutes and opinions for information purposes. It is not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel.