U.S. IRS Says Expenses Paid From Forgiven Paycheck Protection Program Loans Are Not Deductible

IRS has issued a notice indicating that expenses paid from forgiven PPP loans will not be deductible.

Addressing an issue left open under the CARES Act Paycheck Protection Program (PPP), the IRS on 30 April 2020, held in Notice 2020-32 that expenses paid from PPP loans that result in the loans being forgiven are not deductible for U.S. income tax purposes.

The CARES Act established a fund to make loans to small businesses to assist them in continuing to operate the business and maintain payroll. Section 1106(b) of the Act provides that such loans can be forgiven in their entirety if the proceeds are used for specified purposes during the eight weeks following receipt of the loan. Specifically, under Small Business Administration guidance, forgiveness will occur if 75% of the proceeds are used for wages, and 25% for mortgage interest, rent, and utilities.

Section 1106(i) of the Act specifies that loan forgiveness will not result in any taxable income. This provision is necessary to preempt the operation of portions of the tax code that would ordinarily subject forgiveness of debt to tax. But the provision is silent as to the tax treatment of expenses funded by the forgiven loan.

Although opinions in the tax community have differed, Notice 2020-32 provides the IRS position on the issue.

According to the IRS, section 265 of the Tax Code applies to make the expenses associated with the loan nondeductible. Section 265 is designed to prevent a double tax benefit, and overrides all other sections that permit a deduction if it applies. It says that no deduction is allowable if the deduction is allocable to income that is exempt from taxes. The IRS concludes that there is a direct link between the amount of forgiveness that a loan recipient receives, and an equivalent amount of otherwise deductible expenses. Therefore, deductibility of the expenses would create a double benefit, and is precluded by section 265.

IRS also cites another line of authority holding that otherwise deductible payments for which a taxpayer receives reimbursement are not deductible.

As noted, there is considerable debate as to whether the IRS position is correct. In addition, many commentators have surmised that if Congress had recognized the issue when drafting the CARES Act it would have permitted the deductions, and some expect Congress will eventually resolve it legislatively. However, unless Congress does so, recipients of forgiven PPP loans that also take deductions for the qualifying expenses can expect to be challenged by the IRS, and be subject to penalties if the IRS eventually prevails on the issue.