May 1, 2020
On April 30, 2020, the Internal Revenue Service issued Notice 2020-32 to provide guidance regarding deductibility of otherwise deductible business expenses incurred by taxpayers, receiving covered loans pursuant to the Paycheck Protection Program. The IRS has determined that no deduction is allowed if the payment of the expense results in forgiveness of a covered loan pursuant to the CARES Act, as the income associated with the forgiveness is excluded from gross income for tax purposes.
Under section 1106(b) of the CARES Act, recipients of PPP loans may request forgiveness of indebtedness, in an amount equal to the sum of payments, made for the following expenses during the eight-week “covered period” beginning on the PPP loan origination date: (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. The amount of the PPP loan that may be forgiven is subject to reduction, based on reductions in the number of employees or the compensation of employees is reduced, and no more than 25% of the amount forgiven can be attributable to expenses other than payroll costs.
According to the IRS, Section 265(a)(1) of the Internal Revenue Code and related tax regulations provide that no deduction is allowed for expenses allocable to tax exempt income.
Accordingly, Notice 2020-32 provides:
“NON-DEDUCTIBILITY OF PAYMENTS TO THE EXTENT INCOME RESULTING FROM LOAN FORGIVENESS IS EXCLUDED UNDER SECTION 1106(i) OF THE CARES ACT
To the extent that section 1106(i) of the CARES Act operates to exclude from gross income the amount of a covered loan forgiven under section 1106(b) of the CARES Act, the application of section 1106(i) results in a “class of exempt income” under §1.265- 1(b)(1) of the Regulations. Accordingly, section 265(a)(1) of the Code disallows any otherwise allowable deduction under any provision of the Code, including sections 162 and 163, for the amount of any payment of an eligible section 1106 expense to the extent of the resulting covered loan forgiveness (up to the aggregate amount forgiven) because such payment is allocable to tax-exempt income. Consistent with the purpose of section 265, this treatment prevents a double tax benefit.”
Recipients of PPP loans should carefully consider the merits of requesting forgiveness of indebtedness, in light of the tax consequences affecting deductibility of covered expenses.
Author: J. Michael Vaughn, Shareholder, Enterprise Counsel Group