Double benefit from PPP loan forgiveness eliminated by disallowing deduction for forgiven expenses
Businesses receiving loan forgiveness under the Payroll Protection Program (PPP) are not able to deduct payroll or other expenses for which the loan has been forgiven. In Notice 2020-32 released yesterday, the IRS clarified that PPP loan proceeds used to pay expenses, such as payroll, rent, mortgage interest, and utilities, ultimately forgiven are not deductible for federal tax purposes. This prevents businesses from receiving a double benefit from essentially receiving a federal grant, plus deducting those same expenses on its income tax return.
Under the CARES Act, PPP loan amounts spent on qualifying expenses are eligible to be forgiven if spent during the 8 week period beginning when the loan is distributed (i.e., the “covered period”). However, unlike other debt forgiveness, the CARES Act excludes PPP loan forgiveness from gross income, triggering IRC §265(a) according to the IRS Notice. IRC §265(a) prevents taxpayers from receiving a double tax benefit by prohibiting deductions that are allocable to tax-exempt income. Consequently, PPP loan expenses that ultimately result in tax-exempt loan forgiveness income are not deductible for federal tax purposes.
Some commentators have expressed disapproval as eliminating one perceived incentive of maintaining employees on payroll rather than laying them off to claim unemployment if there is no work for the employees. Nonetheless, the PPP loan offers significant benefits to small businesses, permitting forgiveness for additional expenses beyond payroll.
Buckingham will continue to monitor further guidance and update our COVID-19 resource page with important developments.