The Internal Revenue Service (the Service) has announced in Notice 2020-32, issued on April 30, 2020, that expenses paid with proceeds from a loan received under the Paycheck Protection Program (PPP) are nondeductible if the PPP loan is ultimately forgiven. For example, if PPP loan proceeds are used to cover payroll expenses, those expenses are not deductible as ordinary and necessary business expenses should the PPP loan eventually be forgiven.
Paycheck Protection Program (PPP)
As discussed in greater detail here, a taxpayer may use loan proceeds from a PPP loan to pay (1) payroll costs, (2) certain employee benefits relating to healthcare, (3) interest on mortgage obligations, (4) rent, (5) utilities and (6) interest on any other existing debt obligations (PPP expenses). The loan is forgivable, if, during the eight-week period beginning on the loan’s origination date, the taxpayer uses loan proceeds for (1) payroll costs, (2) any payment of interest on any covered mortgage obligation, (3) any payment on any covered rent obligation and (4) any covered utility payment. Loan forgiveness is, however, subject to reduction if the taxpayer lays off employees or reduces salaries and wages by more than 25 percent.
In general, loan forgiveness results in cancellation of indebtedness income under the Internal Revenue Code (the Code). However, the CARES Act provides that any amount that would be includable in gross income by reason of forgiveness “shall be excluded from gross income.” Despite the foregoing, the CARES Act does not address whether deductions otherwise allowable under the Code remain deductible if the PPP loan is eventually forgiven. Notice 2020-32 seeks to fill that interpretive vacuum.
Absent an exception, all PPP expenses would generally be deductible because they constitute ordinary and necessary business expenses. However, Code section 265 provides that a taxpayer may not deduct "any amount otherwise allowable as a deduction which is allocable to one or more classes of income … wholly exempt from the taxes," including ordinary and necessary business expenses. Applying Code section 265, the Service concludes in Notice 2020-32 that, to the extent that an amount forgiven under the PPP is excludable from gross income, such amount is not deductible as an ordinary and necessary business expenses. This approach, according to the Service, is "consistent with the purpose of Section 265" to prevent "a double tax benefit" from inuring to the taxpayer.
Immediately upon issuance of Notice 2020-32, many members of Congress, on both sides of the aisle, expressed displeasure with the Notice. This included sending a joint letter to Treasury Secretary Steven Mnuchin, arguing that Notice 2020-32 was contrary to Congressional intent. Sen. Chuck Grassley-R and Sen. Ron Wyden-D also introduced the Small Business Expense Protection Act (S. 3612) on May 6, 2020, to ensure that expenses paid with proceeds from a loan received under the PPP are deductible if the PPP loan is ultimately forgiven. While the legislation is yet to pass, it has significant bipartisan support.
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