The Internal Revenue Service (the “IRS”) set forth its position on the treatment of expenses incurred, and paid for, with the use of the proceeds from the Paycheck Protection Program (the “PPP Loan”) in IRS Notice 2020-32 (the “Notice”). In such Notice, the IRS provides guidance regarding the deductibility for Federal income tax purposes of certain otherwise deductible expenses incurred in a taxpayer’s trade or business when the taxpayer receives a loan pursuant to the Paycheck Protection Program.
Pursuant to Section 1102 of the CARES Act, a recipient of a covered loan should use the proceeds of the PPP Loan to pay “Qualified Expenses.”1
Contrary to Congressional intent, the Notice from the IRS states that no deduction is allowed under the Internal Revenue Code (the “Code”) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to Section 1106(b) of CARES Act, and that the income associated with the forgiveness is excluded from gross income pursuant to section 1106(i) of the CARES Act.
Section 1106(i) of the CARES Act addresses certain Federal income tax consequences resulting from covered loan forgiveness, and provides that, for purposes of the Code, any amount that would be includible in gross income of the recipient by reason of forgiveness described in section 1106(b) “shall be excluded from gross income.”
Unfortunately, neither Section 1106(i) of the CARES Act, nor any other provision of the CARES Act, addresses whether deductions otherwise allowable under the Code for the payment of Qualified Expenses by the recipient of the PPP Loan are allowed if the covered loan is subsequently forgiven under section 1106(b) of the CARES Act as a result of the payment of those expenses.
As the CARES Act is silent on the deductibility of Qualified Expenses, this allows the IRS to state in the Notice, to the extent that the CARES Act operates to exclude from gross income the amount of a covered loan that is forgiven pursuant to the terms of the statute, that Section 265(a)(1) of the Code disallows any otherwise allowable expense deduction for the amount of any Qualified Expenses, to the extent such payment of Qualified Expenses results in loan forgiveness pursuant to the PPP loan, because such payment is allocable to tax-exempt income.
What this Notice means for the taxpayer for year-end planning is that Qualified Expenses that were incurred and paid during the 8 or 24 week covered period, will not be deductible for tax purposes.
Most small businesses have booked the PPP Loan on their balance sheet and have reported the Qualified Expenses associated with the PPP Loan on their profit and loss statement as deductible expenses. Our reading of the Notice will require the taxpayer to add back those Qualified Expenses as nondeductible expenses when completing their 2020 tax return.
Proper planning has to be thought out when calculating the businesses taxable income for 2020, and in turn what estimated tax payments need to be made for the business, or if a pass through entity, for the shareholders, partners or owners of said business.
Please contact us at Morella & Associates (412-369-9696) to discuss year-end tax planning and any questions you may have regarding the Notice.
1 Qualified Expenses include (1) payroll costs, (2) certain employee benefits relating to healthcare, (3) interest on mortgage obligations, (4) rent, (5) utilities, and (6) interest on any other existing debt obligations.