No Expense Deduction for Forgiven PPP Loan Amounts
By: Jonathan Wolnik
By now everyone should be aware of the Paycheck Protection Program (“PPP”) that enables small businesses to obtain favorable loans through the SBA. PPP loans may then be subject to repayment by the SBA rather than payment by the borrower, with such an arrangement creating a forgivable “PPP loan.” PPP loans have received tremendous press and commentary over the last several weeks. Visit our Firm’s website at https://www.mccarthylebit.com/blog/ to view prior articles and commentary.
The law and regulatory guidance applicable to PPP loans, including the interplay of PPP loans and the Internal Revenue Code (“Code”), continues to be examined, analyzed, and debated, as the guidance is ambiguous in parts. For example, the CARES Act did not address whether deductions available under the Internal Revenue Code (“Code”) apply to business expenses covered by a subsequently forgiven PPP loan, yet the CARES Act explicitly addresses the issue of excluding income for a forgiven PPP loan from gross income. To help clarify the Internal Revenue Service’s (“IRS”) position on expense deductions, the IRS issued Notice 2020-32. This Notice states the IRS’s position that otherwise deductible business expenses for which the borrower pays with PPP loan proceeds from a loan that is subsequently forgiven shall not constitute deductible business expenses on the borrower’s income tax return.
Generally, taxpayers by statute are permitted a deduction for all ordinary and necessary business expenses paid or incurred in a taxable year, which typically includes rent, utilities, and payroll. Rent, utilities, and payroll also happen to be the cornerstone of forgivable expenses under the PPP loan program. But as the Notice states, the IRS is taking the position that allowing such deductions in conjunction with PPP loan forgiveness would create an unintended double benefit to the borrower. Therefore, citing to certain statutory provisions (that may or may not be applicable from a strict statutory construction standpoint) and certain case law interpretations, the IRS takes an announced position that expenses paid by a PPP loan that is subsequently forgiven are not deductible. There is some question as to the statutory basis for the IRS position on this issue and we assume there will be further debate and discussion. Congressional action may even be necessary to resolve it.
PPP loan borrowers will have the burden of tracking, documenting, and justifying forgivable expenses for their lenders, when the borrower applies for loan forgiveness. The same documentation should be shared with the borrower’s tax preparer to ensure a proper reconciliation of business expenses and deductions occurs. This will enable to borrower to avoid claiming improper business expense deductions due to PPP loan forgiveness, at least pursuant to current IRS guidance. But again, this may change if Congress acts.
Guidance pertaining to the PPP loan programs continues to move at a furious pace. Business owners should be constantly working with their professional advisors to ensure their interests are protected during these challenging times. Please contact a McCarthy, Lebit tax attorney to discuss planning opportunities for your business.
Jonathan Wolnik is an attorney at the Cleveland, OH-based law firm McCarthy, Lebit, Crystal & Liffman.
While we would be thrilled to work with all individuals, institutions and companies that read our advisories, we want to clarify that these insights do not form a lawyer-client relationship and represent only general guidance without access or reference to all of the specific facts and circumstances. If you do wish to engage McCarthy Lebit on a specific matter, please contact us by calling 216-696-1422 or by filling out an inquiry form located here. If you are already a firm client, please contact the McCarthy Lebit attorney you work with to discuss these advisories and/or the nature of your concern. In closing, please understand that the law, especially during this pandemic, is changing rapidly and we would recommend that you regularly contact your legal counsel to ensure that your actions are taken based on the most up-to-date versions of the laws.