CARES Act

New IRS Guidance Denies Deduction Related to PPP Loan Forgiveness

Thursday evening, the Internal Revenue Service issued Notice 2020-32 indicating that if loan proceeds under a Payroll Protection Program (PPP) loan are later forgiven, none of the business expenses paid with those funds will be deductible for Federal income tax purposes.

Under the original text of the CARES Act, PPP loan proceeds that are received by the borrower and later forgiven under section 1106(b) – the loan forgiveness provision of the Act – would be excluded from gross income for Federal income tax purposes. However, it was unclear whether the associated business expenses paid for by the loan and later forgiven would be deductible. In today’s notice, the IRS clarified its position, which could have a significant impact on tax and cash flow planning for PPP borrowers.

For example, if a company has $100,000 of PPP proceeds to cover rent expense that it would have had to pay regardless of whether it borrowed under the PPP, and the amount borrowed was later forgiven, the company would lose the ability to offset the $100,000 of rent expense against other business income. At a 30% tax rate, the net cost of the rent would be $30,000. While this still provides companies with some relief, it does not provide the full economic relief that many anticipated.

The IRS based its conclusion on current tax law, which specifies that deductions can’t be taken if they are paid from funds that are considered tax-exempt income. Congress has the power to change this new guidance by issuing legislation that would allow a deduction, assuming it can agree this is the step it wants to take. If so, the change could be included in a subsequent coronavirus-related bill. There are instances when Congress has previously acted in this manner to correct an unfavorable outcome.

It will be interesting to see whether Congress decides to act on this new wrinkle for businesses that have taken a PPP loan. We will continue to monitor the situation and keep you appraised of any developments. If you have any questions about these or any other matters in the meantime, please contact your Kreischer Miller relationship professional or any member of our team. We also continue to update our COVID-19 Resource Center, which you can access here.

Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect, or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.