Under the new CARES Act, Congress has authorized the Paycheck Protection Program (“PPP”), pursuant to which forgivable loans can be made to certain qualified businesses in order to provide economic support during the COVID-19 pandemic. A detailed discussion of the PPP program can be found here. One of the benefits of the PPP loan forgiveness program is that the CARES Act specifically excludes from income any debt cancellation income that would otherwise result from the forgiveness of the PPP loan.
When the CARES Act was adopted, few questioned whether expenses paid with the proceeds of a forgivable loan, such as wages, rent and utilities would be deductible. However, in Notice 2020-32 the Internal Revenue Service announced that its position on this issue: any expenses paid with proceeds of a PPP loan that is forgiven will not be permitted to be deductible for federal income tax purposes.
The IRS guidance is based on Internal Revenue Code Section 265, which provides that no deduction is allowed to a taxpayer for an expense that is allocable to certain classes of income that is itself wholly exempt from income tax. Said another way, in cases when a taxpayer receives tax exempt income, expenses associated with that income are not eligible for income tax deduction.
In Notice 2020-32, the IRS concluded that if a taxpayer is able to exclude from gross income the amount of a PPP forgiven loan, then any expenses paid with the proceeds from such forgiven loan will not be treated as deductible because such payment is allocable to tax-exempt income. From the IRS’s perspective, this treatment is necessary so as to prevent a double tax benefit.
However, as of the date of this post, there is already a bipartisan effort in Congress to adopt legislation that would overrule the IRS’s position. Both Senate Finance Committee Chairman Chuck Grassley and House Ways and Means Committee Chairman Richard Neal have indicated that they would support action to permit the deduction of expenses funded from PPP forgivable loans.