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Expenses Paid by PPP Loan, Which Is Subsequently Forgiven, Are Not Deductible  

by Michael Cumming, Thomas Vaughn, Alexis Schostak, Asel Lindsey

Published: May, 2020

Submission: May, 2020

 



On April 30, 2020, the Internal Revenue Service (“IRS”) issued Notice 2020-32, 2020-21 I.R.B. 1, providing guidance on the deductibility of certain expenses incurred pursuant to the Paycheck Protection Program (“PPP”) of the Coronavirus Aid, Relief and Economic Security Act, Pub. L. No. 116-135 (“CARES Act”). The IRS held that if a taxpayer receives a PPP loan (“covered loan”), uses the loan proceeds to pay for qualified trade or business expenses, and a portion of the loan is subsequently forgiven, no deduction would be allowed for such otherwise deductible expenses paid with the forgiven portion of the covered loan.


The CARES Act allows a recipient of a covered loan to qualify for partial or full loan forgiveness if the loan proceeds are used during the initial eight-week period to pay for certain qualified expenses, including payroll costs, certain mortgage interest, rent, and utility expenses (“eligible expenses”). The amount of loan forgiveness varies based on the taxpayer’s ability to meet all the requirements of Section 1106 of the CARES Act. To the extent any portion of the covered loan is forgiven, the CARES Act provides that such amount would be excluded from gross income of the taxpayer. However, the CARES Act does not address whether eligible expenses paid by the proceeds of a covered loan which are subsequently forgiven would be deductible for Federal income tax purposes.


As a general rule, under Sections 161, 162 and 163 of the Internal Revenue Code (“Code”) a taxpayer is allowed certain deductions incurred in connection with a trade or business, including ordinary and necessary expenses such as rent, utility and payroll costs, as well as certain interest expenses. However, Section 265(a)(1) of the Code disallows any deduction for expenses allocable to one or more classes of exempt income. The IRS held that to the extent the amount of the forgiven covered loan is excluded from income under Section 1106 of the CARES Act, then the application of Section 1106 would result in a “class of exempt income” and any expense allocable to such income would not be deductible for Federal income tax purposes.


The IRS stated that the purpose of disallowing the deduction was to prevent a double tax benefit pursuant to which a taxpayer would be able to exclude from gross income any covered loan proceeds that are subsequently forgiven and also deduct from its gross income eligible expenses paid by such loan proceeds. After the release of the Notice, several members of Congress expressed disappointment with the IRS’s position on non-deductibility of eligible expenses based on concerns that such a view was contrary to the congressional intent to provide liquidity and support small businesses. Whether or not Congress will address this issue in the next relief package remains to be seen.


For more information regarding Notice 2020-32, please contact Michael Cumming (248-203-0740 or [email protected]), Thomas Vaughn (313-568-6524 or [email protected]), Alexis Schostak (248-203-0598 or [email protected]), Asel Lindsey (210-554-5298 or[email protected]), or your Dykema relationship attorney.


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