NON-DEDUCTIBILITY OF PAYCHECK PROTECTION PROGRAM FORGIVENESS EXPENSES
The IRS has recently published in Notice 2020-32 that any expenses paid by the Paycheck Protection Program (“PPP”) loans that are forgiven are not tax deductible. Note the forgiveness would be tax exempt and expenses that do not result in forgiveness would still be deductible, but those expenses that specifically result in forgiveness are not tax deductible.
As a quick background, under the PPP, small business employers were able to receive loans of up to 2.5x monthly compensation (capped off at $100,000 annualized for each employee). The treatment of the loans depended on how the funds were used as the main incentive was to help employers keep employees on payrolls so they have funds to pay their living expenses. If the PPP funds were used for certain qualified expenses such as payroll costs, health insurance, certain employee benefits, interest on mortgage obligations, rent, utilities, and interest on existing debt obligations within the eight week “covered” period after the issuance of the loan, then subject to certain percentage limitations the PPP loan would result in a forgiveness amount (“Forgiven Payments”), and treated as a tax exempt grant. The remaining portions of the loans would be treated as a deferred low interest loan.
In ordinary times, the portion forgiven would usually be treated as cancellation of indebtedness and be taxable income to the extent forgiven, but Section 1106(b) of the CARES Act expressly excludes such forgiven debt from income. As a result, the IRS has published Notice 2020-32 for clarity that under Section 265(a)(1) of the Internal Revenue Code (the “Code”) and Treas. Reg. Section 1.265-1, that expenses relating to the tax exempt income (i.e. the Forgiven Payments) are not tax deductible. IRS would argue to do otherwise would permit businesses to exempt the income twice: once by excluding it from income due to the CARES Act, and again a second time by adding that same amount to deductible expenses which will further reduce net income. The IRS would argue that this puts it on parity with those not receiving PPP loan forgiveness and how taxes are treated in ordinary times.
However, these are not ordinary times. Most businesses are losing large percentages of their revenues and their alternative is to layoff workers placing them on the already overtaxed unemployment compensation system. Business owners do not have their usual cash flow to pay for their own living expenses let alone, in the absence of the PPP, for the living expenses of all its employees and their families. Arguably, the forgiveness was meant to be a tax subsidy in contravention to the IRS’s point of view to help businesses and as an incentive for them to keep existing payrolls in place versus taxing the unemployment system even further. The tax benefit of a double deduction of forgiven PPP loans is minimal compared to the amount most businesses lost and is the least that the federal government could do to help ailing small businesses get back on track once this is finally over. Businesses would argue the IRS is being tone deaf ignoring the realities that many thriving businesses that are now at a halt, and their ruling negates an intentional tax subsidy provided by the CARES Act to help. As a result, if you are a business that has suffered irreparable harm and is struggling due to the recent COVID-19 pandemic, and you need any help you can get to stay afloat, I respectfully recommend contacting President Trump, your federal senators, congress representatives and any other federal public officials about how the IRS Notice is tone deaf and the final shot in the back to businesses that may never recover as they are down. Ask them to set forth a bill and vote to negate this Notice 2020-32 so businesses can deduct all of the operating expenses that they incur during these troubling times regardless of the PPP forgiveness grant.