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Client Alert: Diminished Deductions for the Use of Certain PPP Loan Proceeds

Date: May 5, 2020
In Notice 2020-32, the IRS answered the question that had been the subject of wide discussion and debate (at least among tax attorneys) as to whether borrowers under the Paycheck Protection Program (“PPP”)[1] could deduct the cost of expenses paid with PPP proceeds that are forgiven under Section 1106 of the CARES Act. Answer: No.

The IRS reached this conclusion based on Section 265 of the Internal Revenue Code (“IRC”) and its regulations, the purpose of which “is to prevent a double tax benefit,” which, according to the IRS, would result from permitting a deduction on the use of income that was not subject to taxation (as a result of PPP loan proceeds being forgiven tax free).

As an example, say Acme Corp. receives a PPP loan of $100,000.  Acme Corp. spends the $100,000 on business expenses (generally deductible under IRC §162).  Subsequently, Acme Corp. qualifies for $90,000 of the loan to be forgiven because it was spent on qualified expenses within the required time period.  Acme Corp. does not recognize the $90,000 of cancellation of indebtedness income (because the CARES Act specifically provides an exclusion).  However, according to the IRS, Acme Corp. cannot deduct the $90,000 of business expenses paid with PPP funds for which the loan was forgiven and can only deduct the $10,000 of expenses for which there was no loan forgiveness. 

If all of this occurs in 2020, then it is relatively straightforward.  If the forgiveness occurs in a different year, then it is a bit more complicated, because the prior deduction will need to be unwound.

Keep in mind that this is the IRS interpretation of the CARES Act—many scholarly commentators believed that this was going to be the IRS position but there are arguments that this should not be the result and it is possible that this interpretation will be challenged and could change, either with legislation from Congress or court decisions.  Sen. Chuck Grassley, the chairman of the Finance Committee, said Thursday, April 30, that he was disappointed in the IRS decision: “The intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible…this Notice is contrary to that intent.”

If a taxpayer takes a contrary position, it should be disclosed on the tax return and is likely to be audited.  It remains to be seen how the disallowed deduction will play out in light of guidance from the Treasury and SBA that PPP loans in excess of $2 million will automatically be reviewed.  If the loan is not forgiven until after the review, there could be considerable time between the year the expenses are incurred (2020) and the year the debt is forgiven.
 
[1] For detail about the PPP, please refer to our COVID-19 resource page, https://www.wtplaw.com/practices/covid-19.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.