IRS NOTICE PROVIDES THAT PPP LOAN FORGIVENESS EXPENSES ARE NOT DEDUCTIBLE

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BACKGROUND

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) passed the Paycheck Protection Program (“PPP”). Under the PPP, certain eligible small businesses are allowed to borrow funds. If certain parameters are met, the loan will be forgiven.[1] Typically, when a loan is forgiven, unless the taxpayer was insolvent at the time or otherwise met the exceptions under the Code §108,[2] the amount of loan forgiven would be included in the taxpayer’s gross income. Under the CARES Act, the amount forgiven as a result of this program is excluded from gross income. However, there were many issues that were ambiguous. In particular, as the PPP program requires the loan to be used for payroll and certain other permittable business expenses, the question remained whether the taxpayer would receive a tax deduction for the business expenses allocable to the program.

NOTICE 2020-32

On April 30, 2020, the IRS released Notice 2020-32. This Notice provides that the taxpayer is not eligible to deduct the PPP expenses if the loan is forgiven. The IRS bases their decision on Code §265 and the regulations thereunder. In particular, the IRS states that the loan forgiveness under the program is a “class of exempt income” and therefore the expenses allocable to the loan forgiveness is disallowed these provisions. The rationale behind the notice is to disallow a double benefit. A copy of the notice is attached.

KEY INSIGHTS

It’s not entirely clear if Çongressional intent was to disallow the deduction as this reduces the net overall benefit of the program in time of coronavirus crisis. The program was designed for relief for small businesses. Senator Chuck Grassley (R-Iowa) has stated disappointment with the decision. Richard Neal (D-Mass) has stated that this will be fixed in the future. We expect legislative reversal in future stimulus plans.

If is not fixed, we note that under the Code §265 regulations, the taxpayer must submit with his or her return an itemized statement in detail showing the class of exempt income and the allocations. Therefore, tax preparers should ensure this requirement is met in the next tax filing season and update their checklists accordingly.

[1]           These requirements and PPP loan forgiveness are discussed in other Gray Tolub LLP publications which can be found at: https://graytolub.com/publications.

[2]           References are to the Internal Revenue Code of 1986, as amended from time to time (the “Code”).