IRS Issues Guidance on Tax Impact of PPP Loan Forgiveness Under the CARES Act
The Internal Revenue Service (IRS) recently issued Notice 2020-32 (Notice), which discusses the deductibility of expenses that are funded by a Paycheck Protection Plan (PPP) loan and the subsequent loan forgiveness. Section 1106 of the Coronavirus Aid, Relief, and Economic Security CARES Act (CARES Act) states that loan proceeds used for certain types of expenses, such as payroll costs and certain payments of interest, rent and utilities, can be forgiven and that the loan forgiveness is excluded from gross income under the Internal Revenue Code of 1986, as amended (Code).
The Notice denies a tax deduction for an expense funded by a PPP loan that is subsequently forgiven and this interpretation of the CARES Act, and the intersection of the PPP loan provisions and available tax deductions, is raising significant concern with businesses as well as already triggering requests for legislative relief. In addition, businesses that decided to take a PPP loan in lieu of the employee retention credit under Section 2301 of the CARES Act (Credit) now lose tax deductions that were factored into their economic analysis of the benefit of obtaining a PPP loan or using the Credit.
The Notice first summarizes the PPP loan provisions and the availability of loan forgiveness. The Notice then confirms that any loan forgiveness does not result in income under the Code based on Section 1106(i) of the CARES Act, with this income exclusion operating as a specific override of the normal income inclusion rules that apply when debt is cancelled or forgiven. The Notice finally observes that neither “section 1106(i) of the CARES Act nor any other provision of the CARES Act addresses whether deductions otherwise available under the Code for payments of eligible section 1106 expenses by a recipient of a covered loan are allowed if the covered loan is subsequently forgiven” as a result of the payment of the expenses.
The IRS reaches its conclusion based on Code Section 265(a)(1), which states that an otherwise allowable deduction cannot be claimed where the deduction relates to income that is wholly exempt from taxes. The IRS believes that its conclusion is required in order to prevent a “double tax benefit” that would result if expenses funded with a PPP loan that is forgiven can be deducted.
We have a few observations on this analysis. First, the IRS assumes that the goal of preventing a double tax benefit is what the CARES Act intended to accomplish. Unlike Code Section 265(a)(1), we are not aware of any specific reference in the tax provisions of the CARES Act that deny the deduction or that suggest there is any inconsistency between the allowed loan forgiveness and an otherwise allowable tax deduction. Second, the CARES Act delegates to the Treasury Department authority to issue guidance on certain tax issues, but the Small Business Administration (SBA) is granted authority to issue guidance or regulations on the loan forgiveness issue, so perhaps the SBA will comment on this issue. Finally, an IRS notice certainly falls within the scope of “substantial authority” under Code Section 6662, so this presents a challenge if a taxpayer intends to take a tax reporting position that the Notice is not correct.
Hopefully Congress will provide guidance on this issue on an expedited basis, particularly since businesses may have relied on the ability to deduct the expenses as part of their PPP loan versus Credit analysis.
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.
 See CARES Act Employee Retention Credit: A Detailed Analysis (4/3/2020) and CARES Act Employee Retention Credit Update (4/17/2020)