IRS Guidance Disallows Deductions for Expenses Paid in Connection with Forgiven PPP Loans
On April 30, 2020, the Internal Revenue Service (the “Service”) issued Notice 2020-32 (the “Notice”), which takes the position that taxpayers are not able to deduct otherwise allowable expenses to the extent the payment results in the forgiveness of loans under the Paycheck Protection Program (the “PPP”) of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act provides for PPP loans that are forgivable if the recipient spends the loan proceeds on specified costs, including payroll costs, mortgage interest payments, rent payments, and utility payments. The CARES Act further provides that the borrower shall not include in gross income any amount (to the extent otherwise includible in income without regard to the CARES Act) from the forgiveness of the PPP loan. For more information on the CARES Act, see the Honigman CARES Act and Covid-19 Quick Reference Guide.
The Service’s conclusion on the deductibility of expenditures financed with PPP loan proceeds is based on a tax code provision that prohibits deductions for amounts allocable to tax-exempt income. The Notice states that, because the CARES Act excludes qualifying forgiven PPP loans from income inclusion, the expenditures giving rise to the loan forgiveness are allocable to tax-exempt income. The Notice further states that allowing a deduction of PPP expenses would result in a double tax benefit to taxpayers.
Unless the Services modifies or revokes the Notice, then absent Congressional action taxpayers will effectively be required to include the proceeds of a forgiven PPP loan in income. That is, if an employer pays wages using PPP loan proceeds and the loan is subsequently forgiven, the employer would not be able to deduct the wages from its taxable income. This leads to the same tax result as if the employer were taxed on the PPP loan forgiveness and deducted the corresponding wages.
The Service’s position on deductibility of expenses funded by PPP loans is contrary to the expectations of many taxpayers and members of Congress. Senate Finance Committee Chair Chuck Grassley and other Senators have criticized the position taken by the Service in the Notice as being contrary to purposes of the CARES Act in general and the PPP specifically. They have introduced bipartisan legislation to permit the deduction of expenditures financed with PPP loan proceeds. House Ways and Means Committee Chair Richard E. Neal has stated that the House plans to pass similar legislation. These members of Congress have also written Secretary of the Treasury Mnuchin, requesting a reconsideration of the Service’s position in the Notice.
Until such legislation is enacted or the Notice is modified or revoked, the Notice reflects the position of the Service on the deductibility of expenses that give rise to forgiveness of PPP loans, and taxpayers should consider the effects of the position in business planning. Please contact any attorney from Honigman’s Tax practice group for further information on the deductibility of PPP expenses or the CARES Act’s tax provisions more generally.