Paycheck Protection Program Loan Forgiveness and Tax Deductions

On April 30, 2020, the IRS announced in Notice 2020-32 (the Notice), its position regarding the disallowance of certain otherwise allowable tax deductions for a borrower (taxpayer) that is forgiven repayment of a Paycheck Protection Program (PPP) loan. While the notice is apparently contrary to the intent of Congress and not entitled to judicial deference because it was issued without prior notice and comment, the IRS nevertheless will attempt to enforce it. 

In the Notice, the IRS acknowledges that the forgiveness of a PPP loan is excluded from gross income under the Internal Revenue Code (Code). However, the IRS classifies PPP loan forgiveness as a “class of exempt income.” Under Section 265(a)(1) of the Code, expenses allocable to a “class of exempt income” are not allowable as tax deductions.

So, while the Code generally allows business taxpayers to deduct ordinary and necessary expenses paid or incurred during a taxable year (subject to certain limits), including payroll (consisting of wages and benefits paid to employees), real property and personal property mortgage interest, rent obligations and utilities, if PPP loan proceeds are used to fund these expenses and the PPP loan is forgiven, the IRS position is that no tax deductions are allowed for these expenses.

The IRS stated that the purpose for the Notice is to avoid allowing a taxpayer to obtain a double tax benefit by way of receiving both tax exempt income from PPP loan forgiven amounts and tax deductions for expenses paid with those same loan proceeds. 

To summarize, the IRS position is that expenses paid with forgivable PPP loan proceeds cannot be claimed as tax deductions on the 2020 tax returns filed for a business. However, there is a slight possibility that Congress will take legislative action to overrule Notice 2020-32. Stay tuned.

co-written with Christina Moore, Partner at Taylor English