United States

Forgiven PPP loans result in disallowed deductions

TAX ALERT  | 

In Notice 2020-32, the IRS disallows deductions for expenses paid using loan proceeds from the Paycheck Protection Program (PPP) to the extent of the forgiveness and exclusion from income for the loan proceeds.

Background

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) established the PPP. The PPP generally allows a recipient of a loan to use the proceeds to pay:

  1. payroll costs;
  2. certain employee benefits related to health care;
  3. interest on mortgage obligations;
  4. rent;
  5. utilities; and/or
  6. interest on any other existing debt obligations.

Recipients can receive forgiveness of the loan in an amount equal to the sum of payments made for items one through five on the list above during the covered period (eight weeks from the loan’s origination date). The amount of the forgiveness, however, decreases if during the covered period there are certain reductions in the number of full-time employees and wages or salaries of certain employees. Additionally, no more than 25% of the amount forgiven can be attributable to non-payroll costs.

Tax consequences

The CARES Act provides that for federal income tax purposes any amounts forgiven related to a PPP loan shall be excluded from gross income. In determining the tax treatment of the expenses paid for with the forgiven PPP loan proceeds, the IRS primarily considers the application of section 265. Section 265, a provision intended to prevent a double tax benefit, disallows deductions allocable to classes of income exempt from tax. The IRS states that the application of the CARES Act provision that excludes forgiven amounts from income results in a class of exempt income under the section 265 regulations. Accordingly, section 265 disallows otherwise allowable deductions for the amount of any payment of the qualified expenses listed above to the extent of the loan forgiveness because such payment is allocable to tax-exempt income. To further support the conclusion, the IRS cites case law related to denying deductions for otherwise deductible expenses when a taxpayer receives a reimbursement. 

While this guidance would seem to eliminate the debate among tax professionals on the treatment of the expenses related to the PPP that is forgiven, it may not be the final word. Senate Finance Committee Chair Chuck Grassley, R-Iowa, expressed disappointment in the IRS conclusion. Grassley issued a statement that “[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,” and “[t]his notice is contrary to that intent.” The House, Ways and Means Committee Chair Richard E. Neal, D-Mass., indicated that Congress may address this outcome in the next round of legislation.

Taxpayers should carefully consider the implications when evaluating the full impact of the PPP debt forgiveness provision.

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