IRS Concludes No Deduction Allowed For Expenses Paid With Forgiven PPP Funds
Articles by: Richey May, May 08, 2020
The IRS recently released Notice 2020-32 which addresses the tax deductibility of expenses paid with PPP loan funds that are subsequently forgiven pursuant to Section 1106 of the CARES Act. Unfortunately, while the receipt of a loan that is forgiven is still more beneficial than the tax savings of a deduction this IRS guidance reduces the benefit of the loan that is forgiven.
The CARES Act does not address whether deductions that would otherwise be permitted in calculating taxable income are deductible if the covered loan is subsequently forgiven. The IRS has determined that “Section 265(a)(1) of the Code applies to otherwise deductible expenses incurred for the purpose of earning or otherwise producing tax-exempt income. It also applies where tax exempt income is earmarked for a specific purpose and deductions are incurred in carrying out that purpose. In such event, it is proper to conclude that some or all of the deductions are allocable to the tax-exempt income”.
The IRS concludes that forgiveness of the loan will result in a “class of exempt income” under 1.265-1(b)(1) of the Regulations. Therefore, the IRS believes that in order to prevent a double tax benefit, code section 265 disallows any otherwise allowable deduction (up to the aggregate amount forgiven) because the payment is allocable to tax-exempt income. Treasury Secretary Steven Mnuchin doubled down on this position in a televised interview earlier this week by saying “The money coming in the PPP is not taxable. So, if the money that is coming is not taxable, you cannot double dip. You cannot say that you are going to get deductions for workers that you did not pay for”.
This may not be the last we hear on this issue. Many tax practitioners and professional organizations do not believe this result was Congress’s intent. In fact, Senate Finance Committee Chairman Chuck Grassley, ranking member Ron Wyden, and House Ways and Means Committee Chair Richard Neal wrote in a letter to Secretary Mnuchin stating “We believe the position taken in the Notice ignores the overarching intent of the PPP, as well as the specific intent of Congress to allow deductions in the case of PPP loan recipients. As was expressed to Treasury during the development of the PPP, we did not intend to deny the deductibility of ordinary and necessary business expenses, nor did these small businesses expect to lose deductions for their business expenses when they applied for a PPP loan.” Therefore, Congress may act in a future Coronavirus relief bill to specifically state these expenses are in fact deductible. Additionally, the AICPA has announced it plans to seek legislative clarification on the issue. Richey May will continue to monitor any changes to this information that may develop as well as additional guidance from the IRS to keep you informed as it becomes available.