By Demetrius Robinson, Kevin O’Connor & Melissa Yasinow
On Thursday, April 30, the IRS announced Notice 2020-32, providing its position that expenses paid with a forgivable loan under the Payroll Protection Program (PPP) are not tax-deductible. Established under the CARES Act, small businesses can receive forgivable loans through the PPP to cover “eligible expenses” including payroll cost, mortgage interest, rent, and utilities (See Forgivable Use). Under Sections 162 and 163(a) of the Internal Revenue Code, businesses may typically deduct ordinary and necessary expenses incurred in conducting their operations including “eligible expenses.” However, Notice 2020-32 appears to limit the ability of a taxpayer to deduct these expenses if they were paid with the proceeds of a forgiven PPP loan.
Typically, forgiven debt is treated as taxable income under Section 61 of the Tax Code. However, Congress explicitly exempted forgiven PPP loans from this tax treatment under Section 1106 of the CARES Act. To prevent what the IRS calls a “double tax benefit,” it issued Notice 2020-32 announcing its position that businesses that pay eligible, forgivable expenses with PPP funds should not deduct the same expenses as ordinary and necessary business expenses under Section 162 and 163(a) of the Code.
While the rationale of the IRS may be to prevent a “double tax benefit,” this rationale may not be consistent with the intent of Congress when drafting the legislation. The PPP loan was meant to encourage employers to retain their employees and not necessarily prevent them from receiving an additional benefit for doing so. The IRS, under this notice, is treating the forgivable portion of a PPP loan analogous to a reimbursement. Therefore, under Section 265(a)(1), the IRS believes that any incurred eligible expenses that are paid with PPP loan proceeds are not deductible to the taxpayer under Section 162 or 163(a). While the IRS guidance may be persuasive, it does not have the authority of law. Businesses that have received a PPP loan are encouraged to work closely with their tax professional in order to understand the implications of the inability to deduct otherwise “eligible expenses” if a PPP loan is forgiven.
In deciding whether to pursue a PPP loan or retain a PPP loan—which was recently replenished with another $310 billion—businesses should carefully consider their particular needs and the tax implications for participating in the PPP loan program. Finally, a PPP loan has several permitted uses but not all of these uses are “eligible expenses” for purposes of loan forgiveness. Businesses should be aware of the eligible expenses that are forgivable under the PPP loan program and work to appropriately document these expenses in order to increase the likelihood of forgiveness. Businesses looking to maximize forgiveness should carefully review the criteria including understanding limiting PPP loan proceeds for non-payroll costs to 25% or less, retaining employees and limiting reductions in employee compensation. (For more information on PPP loan forgiveness, please see our previous post—PPP Loans: Preparing for Forgiveness).
In these uncertain times, it is vital that businesses be aware of all of their options and obligations. If you have questions about the tax consequences of the PPP or the CARES Act on your business or would like to discuss ways to neutralize the impact, please contact Demetrius Robinson (djr@kjk.com; 614.427.5749), Kevin T. O’Connor (kto@kjk.com; 216.310.4938) or Melissa Yasinow (may@kjk.com; 216.736.7205), or reach out to any of our Tax professionals.