IRS Guidance on Expenses Paid with PPP Loans
On April 30, 2020, the Internal Revenue Service (IRS) issued Notice 2020-32 (Notice) which claims that expenses will be nondeductible if paid using loan proceeds that are later forgiven under the Paycheck Protection Program (PPP) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
The PPP was established as a low-interest emergency loan program to enable employers to retain employees and cover overhead costs along with the potential for loan forgiveness. Furthermore, the recently enacted Paycheck Protection Program Flexibility Act (PPPFA) was passed which modifies certain provisions from the CARES Act related to PPP loans. For more information about the PPP loan program and the rules changes from the PPPFA, see the following True Alerts: IRS Guidance & Loan Assistance to Businesses; The Paycheck Protection Program Flexibility Act & Treasury/IRS Guidance in Response to COVID-19.
According to section 1106 of the CARES Act, and as modified by PPPFA, PPP loans are eligible for forgiveness to the extent that funds are used to pay “eligible expenses” by the earlier of either December 31, 2020 or 24 weeks after the loan origination date (covered period). At least 60-percent of the eligible expenses must be spent on payroll-related costs with the remainder applied to other predefined expenses that include rent, utilities, and interest on mortgage obligations. The amount of the PPP loan that is eligible for forgiveness may also be reduced if the employer fails to meet other criteria such as maintaining the number of, and salary paid to, full-time employees.
Taxpayers, who are typically required to recognize cancellation of indebtedness (COD) income for any debt that is discharged or forgiven under Internal Revenue Code (IRC) sections 61(a)(11) and 108, are expressly permitted to exclude the amount of PPP loan forgiveness from their taxable income under section 1106(i) of the CARES Act. However, the CARES Act does not specify the tax treatment of eligible expenses that are used to qualify PPP loans for forgiveness (qualifying eligible expenses).
IRS Notice 2020-32
The IRS released the Notice to clarify its position that taxpayers may not deduct qualifying eligible expenses. To support this position, the IRS points to IRC §265(a) and the related treasury regulations that generally disallow deductions if the expenses are allocable to tax-exempt income in order to avoid a double tax benefit. The IRS further states in the Notice that:
“The deductibility of payments of eligible section 1106 expenses that result in loan forgiveness under section 1106(b) of the CARES Act is also subject to disallowance under case law and published rulings that deny deductions for otherwise deductible payments for which the taxpayer receives reimbursement.”
Many organizations, including the AICPA and U.S. Chamber of Commerce, have criticized the Notice on the basis that it negatively impacts troubled taxpayers and conflicts with congressional intent. That criticism is supported by a provision in the Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act which was recently passed by the House and includes a provision to override the Notice by expressly authorizing deductions for qualifying eligible expenses. Another bill that was recently introduced in the Senate – the Small Business Expense Protection Act of 2020 – would also override the Notice, but the Senate has not yet voted on either bill.
For now, businesses that borrowed PPP loans should be prepared to treat their qualifying eligible expenses as nondeductible. However, TPC will continue to monitor for further developments and will provide an updated if one of the aforementioned bills or similar legislation is enacted to allow these deductions.
Please contact a member of your TPC engagement team if you have any questions about this topic or to learn more about how TPC can help.