IRS Denies Deductions for Expenses Paid with Forgiven PPP Loan Proceeds
The Coronavirus, Aid, Relief and Economic Security Act (CARES Act) establishes the Paycheck Protection Program (PPP). The program provides an incentive for small businesses to keep workers paid and employed. The amount of PPP loan proceeds used for qualifying expenses during the 8-week period beginning when the loan is made are eligible for forgiveness. Any forgiven amounts are excluded from gross income pursuant to section 1106(i) of the CARES Act. On April 30, 2020, the Internal Revenue Service published Notice 2020-32 (the Notice) that announces that otherwise deductible business expenses funded by proceeds from a forgiven PPP loan are not deductible for federal income tax purposes. The Notice is available here.
The Notice asserts that excluding the amount of the forgiven PPP loan from gross income while also allowing the expenses paid with the forgiven loan amount to generate a tax deduction creates a “double tax benefit.” To prevent this, the Notice treats forgiven amounts as a “class of exempt income” under Treasury Regulation §1.265-1(b)(1). Section 265(a)(1) of the Internal Revenue Code of 1986, as amended, in turn disallows otherwise allowable deductions, including deductions under section 162 for ordinary and necessary business expenses and section 163(a) for business interest expenses, if such payments are allocable to tax-exempt income. This treatment effectively negates the tax-free nature of the loan forgiveness provided by section 1106(i) of the CARES Act.
Bipartisan lawmakers, including Senator Charles Grassley, Chair of the Senate Finance Committee, and Representative Richard Neal, Chair of the House Ways and Means Committee, have expressed disappointment with the Notice and a legislative reversal of the Notice may be enacted. Despite the possibility of a legislative fix, PPP loan recipients should keep the Notice in mind when deciding whether to seek or retain a PPP loan.
We are continuing to monitor changes and developments under federal and state tax law. If you have questions or concerns, please contact a member of the Koley Jessen Tax Practice Group.
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