IRS Releases Guidance on Deductibility of PPP Loan Expenses
The IRS has released guidance on the deductibility of loan proceeds expended in conjunction with the Paycheck Protection Program (“PPP”). The PPP loan program provides forgivable loans to small business concerns to subsidize the maintenance of employee headcount and payroll levels. The PPP is included in Section 1106 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), P.L. 116-136.
The IRS released Notice 2020-32, which disallows expenses that would otherwise be deductible if those expenses are funded with PPP loan proceeds and subsequently forgiven. Under this section of the CARES Act, covered loans are eligible for forgiveness if used for qualified expenses, which include payroll and payroll support costs, payments of interest on covered mortgage obligations, and occupancy costs, including rent and utilities. The Act further excludes any debt extinguishment income from taxable income.
The Notice relies on IRC §265, which disallows the deduction of any amount otherwise deductible under IRC §162 (trade or business expense) or IRC §163 (interest expense) if the income is allocated to any class of wholly tax-exempt income. The section is intended to prevent the double benefit of tax-exempt income coupled with tax deductions. The IRS has further cited Revenue Ruling 83-3, which concludes that deductions are not allowed if the expense is allocable to amounts excludable from gross income.
The AICPA and other groups have taken contradictory positions to that of the IRS with the hopes of achieving legislative changes to this ruling.
The CARES Act itself does not address whether deductions otherwise allowable under the Code for payments of eligible Section 1106 expenses by a recipient of a covered loan are allowed if the covered loan is subsequently forgiven as a result of the payment of those expenses.
The AICPA believes strongly that the IRS’s interpretation denying deductions of expenses forgiven under the PPP program is contrary to Congress’s intent. Chris Hesse, CPA, chair of the AICPA Tax Executive Committee, said: “In effect, the IRS guidance means that the taxability provision [Section 1106(i)] has no meaning. Why waste the ink to say that for purposes of the Code, the loan forgiveness is not includible in income, if the government will just take away deductions in the same amount?”
Because it believes the intent of the CARES Act was to allow businesses to deduct all of their ordinary and necessary expenses — including any expenses used in determining PPP covered costs — the AICPA plans to seek legislative clarification. “We’re hopeful that we’ll see movement on the legislative front early next week,” according to Edward Karl, CPA, AICPA vice president–Tax Policy & Advocacy.
Senate Finance Committee Chair Chuck Grassley, R-Iowa, stated, “The intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible. This Notice is contrary to that intent.” Sen. Grassley has not said if Congress will try to reverse the IRS deduction nix by statute. However, House, Ways and Means Committee Chair Richard E. Neal, D-Mass., announced with his spokesperson Erin Hatch, “We are planning to fix this in the next response legislation.”
We will continue to keep everyone updated on legislative changes to this treatment.
For questions about the PPP, contact David Killion, Transaction Advisory Principal, at 314.983.1304 or firstname.lastname@example.org, Bianca Sarrach, Advisory Principal, at 314.983.1365 or email@example.com or Jen Vacha, Tax Partner, at 636.754.0230 or firstname.lastname@example.org