Taxpayers fortunate enough to have received proceeds from a Paycheck Protection Program loan are now faced with determining how to spend the proceeds in order to secure maximum loan forgiveness. Due to the uncertainty surrounding COVID-19, many employers are still facing government-mandated shut-downs or are struggling with the lack of revenue needed to rehire furloughed/laid-off employees.
The recently passed CARES Act states that a loan recipient can receive loan forgiveness provided they use the proceeds to pay for “eligible expenses” over an 8-week period beginning on the day the loan proceeds are received. For purposes of the forgiveness calculation, eligible expenses include (1) payroll costs, (2) interest on certain mortgage debts, (3) certain rent obligations, and (4) certain utility payments.
While the CARES Act provided some guidelines as to how the forgivable portion of a PPP loan was to be determined, there were many questions left unanswered. One such question is whether the qualified expenses paid with PPP loan proceeds will be deductible in determining taxable income should the PPP loan be forgiven.
The IRS addressed this question in Notice 2020-32, issued April 30, 2020. Based on the guidance contained in the Notice, if the payment of an otherwise deductible expense results in forgiveness of a PPP loan, then no deduction will be allowed for those expenses in determining taxable income. While this may seem, on the surface, to be unfair, keep in mind that the CARES Act also provides that any PPP loan forgiveness is excluded from taxable income.
The conclusion reached by the IRS is consistent with Internal Revenue Code Section 265 which contains a rule that states that no deduction is allowed for any expenses that are allocable to tax-exempt income. The purpose of IRC Section 265 is to prevent a double tax benefit. In the case of a PPP loan that is forgiven, the loan recipient benefits by not having to pay tax on the loan forgiveness. If not for the rule disallowing the deduction, if the payment of the eligible expenses were also allowed as a tax deduction, the loan recipient would benefit a second time on the same dollars.
Regulations further explaining how PPP loan forgiveness is to be determined are expected to be issued by the SBA soon. It is anticipated that many of the unanswered questions will be addressed when these regulations are issued. In the meantime, please contact your WG Advisor if you have any questions or for additional information.
