IRS Bars Potential Double Tax Benefit for Use of PPP Loan Proceeds
Yesterday, the Internal Revenue Service (IRS) issued Notice 2020-32, addressing the deductibility for US federal income tax purposes of some expenses incurred in a taxpayer’s trade or business when the taxpayer receives a loan through the Paycheck Protection Program (PPP). Pursuant to IRS Notice 2020-32, no deduction is allowed under the Internal Revenue Code (the Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan under the CARES Act and if the income associated with the forgiveness is excluded from gross income.
Under the PPP, a recipient of a covered loan may use the loan proceeds to pay:
(i) payroll costs
(ii) costs related to the continuation of group health care benefits during periods of paid sick, medical or family leave and insurance premiums
(iii) employee salaries, commissions, or similar compensations
(iv) payments of interest on any mortgage obligation
vi) utilities, and
(vii) interest on any other debt obligations.
The PPP guidance limits a recipient’s ability to use loan proceeds for non-payroll costs. Moreover, a recipient of a covered loan may receive forgiveness in an amount equal to the sum of payments made during the eight-week period following loan origination for payroll costs, payments of interest on any covered mortgage obligation, payments on any covered rent obligation, and covered utility payments (subject to limitations on forgiveness for non-payroll costs). Under general US tax principles, forgiveness of a debt may result in taxable income to the borrower, but the CARES Act specifically provides that taxpayers will not be subject to cancellation of indebtedness income as a result of such forgiveness.
The CARES Act, however, did not address whether deductions otherwise allowable under the Code for payments of eligible expenses by a recipient of a covered loan are allowed if the covered loan is subsequently forgiven under the CARES Act. Notice 2020-32 makes clear that such deductions will not be permitted, by treating loan forgiveness under the PPP as a “class of exempt income” under the regulations promulgated under section 265 of the Code, which section disallows deductions for expenses and interest incurred to produce tax-exempt income (such as tax-exempt bonds).
It is not entirely clear that the approach taken by the IRS in Notice 2020-32 is consistent with the intent of Congress when it specifically provided that the cancellation of covered loans under the CARES Act would not result in cancellation of indebtedness income to borrowers. By eliminating the deduction, the tax benefit from the associated exclusion from income of the forgiven debt is offset.