Non-deductibility of Expenses Funded with PPP Loan Proceeds

Late last week, the IRS issued Notice 2020-32 which states that no deduction will be allowed for an expense that would otherwise be deductible by a small business if the payment of such expense results in forgiveness under the provisions of the Paycheck Protection Program (PPP) of the CARES Act, and the income associated with the forgiveness is excluded from gross income.

While this pronouncement by the IRS doesn’t technically overturn the CARES Act exclusion regarding forgiveness income, taking the underlying deductions away has the effect of making the forgiven loan amount taxable, which is not what Congress truly intended. The IRS’s approach to reaching such a conclusion relies on Section 265 principles relating to the non-deductibility of expenses that are wholly related to income exempt from tax. The presumed reasoning of the IRS is to not allow taxpayers receiving the PPP funding to “double dip;” once by receiving loan proceeds which do not need to be repaid (and the forgiveness of which is not taxable) AND second, by still allowing taxpayers to take a deduction for the expenses such PPP loan funded.

There is likely to be significant backlash by small businesses that have already made economic decisions based on the fact that taking the loan and having it forgiven would not adversely impact their tax position. Assuming, however, that this IRS position is maintained, the loss of such deductions changes the economics of the forgiveness and could result in a portion of the benefit being paid back to the government in the form of additional taxes. As a result of the inevitable resistance, this pronouncement is not likely to be the end of this discussion, and we will be closely watching any additional developments. We will highlight any further developments on this issue in future newsletters.

Members of the DUGGAN BERTSCH team are available to assist small business employers in determining the impact of this change to the overall economic impact of obtaining PPP funding, and requesting forgiveness of the loan. Please contact your DUGGAN BERTSH representative for more information or assistance.

Team Members: