But Congress may act to enable taxpayers to deduct expenses paid with PPP loan proceeds
On April 30, 2020, the IRS released guidance disallowing deductions for otherwise deductible expenses if payment of the expense results in forgiveness of a covered loan under the CARES Act. Under the Paycheck Protection Program (PPP) of the CARES Act, loan recipients can use the proceeds to fund payroll, certain healthcare benefits, mortgage interest, rent, utilities, and interest on other debt. Generally, these would be deductible expenses. However, IRS Notice 2020-32 disallows these deductions to the extent paid with a forgivable CARES Act loan.
The CARES Act specifically provides that forgiven loans are not included in the taxpayer’s gross income, reversing the normal rule that a forgiven loan gives rise to taxable income. The benefit provided by the CARES Act in the form of excluding forgiven debt from taxable income is effectively reversed by the IRS’s disallowance of deductions for payroll and other expenses funded by the loan. It is debatable whether this is the result Congress intended. Indeed, Chuck Grassley, who chairs the Senate Finance Committee, publicly stated that the IRS’s position was contrary to Congress’s intent. Representative Richard Neal, who chairs the House Ways & Means Committee, announced he intends to introduce legislation to “fix” the problem. Nonetheless, the IRS’s official position is that such deductions are disallowed.
Taxpayers that receive PPP loans that are later forgiven should be aware that, in the absence of further action by Congress or Treasury, there is an associated tax cost. For corporations, this tax cost would generally be 21% of the PPP loan amount. For individual owners of businesses in flow-through form for U.S. tax purposes, this tax cost would be the applicable effective individual rate (generally 37% or higher after taking into account state income tax) multiplied by the PPP loan amount.
