Congress Allows Deduction of Expenses Funded by Forgiven PPP Loan
Earlier this year, the Internal Revenue Service (IRS) issued guidance in Notice 2020-32, Rev. Rul. 2020-27, and Rev. Proc. 2020-51 and held that expenses funded by a Payroll Protection Program (PPP) loan that is forgiven could not be deducted. While the CARES Act provided that the loan forgiveness itself did not create income to the borrower, the CARES Act did not specifically comment on whether expenses associated with a forgiven PPP loan could be deducted. We previously commented on the deductibility issue and suggested that Congress needed to address this issue, particularly since businesses may have relied on the ability to deduct the expenses as part of their PPP loan versus employee retention credit analysis.
Late on December 21, 2020, Congress approved a new $900 billion stimulus bill (Bill) that includes various COVID-related tax relief, including clarification of the tax treatment of the forgiveness of a PPP loan. The Bill provides that if there is a forgiveness of a PPP loan, the expenses associated with the forgiven loan can be deducted (or capitalized, as the case may be). The Bill reverses legislatively the interpretation of the IRS and now provides clear guidance on the deduction issue.
The clarification of tax treatment addressed two additional points:
- First, the expense deduction rule applies to current PPP loans as well as subsequent PPP loans authorized under the Bill.
- Second, there is what seems to be a tax basis neutrality provision for S corporation shareholders and partners.
As a technical tax matter, the PPP loan forgiveness is treated as tax exempt income and the amount of the forgiveness would increase the tax basis in the S corporation stock and partnership interest. The Bill provides that there is an offsetting reduction in tax basis equal to the amount of the tax exempt income, which has the effect of offsetting the tax basis increase, but curiously the offsetting reduction only applies to partnerships.
The Bill provides welcome clarity on the deductibility of PPP loan-funded expenses when the PPP loan is forgiven. We suggest you discuss with your tax advisor how this new provision impacts your business.
As we continue to monitor the novel coronavirus (COVID-19), White and Williams lawyers are working collaboratively to stay current on developments and counsel clients through the various legal and business issues that may arise across a variety of sectors. Read all of the updates here.