Late Thursday, April 30, the IRS issued IRS Notice 2020-32, addressing the deductibility of expenses paid with loan proceeds received under the Paycheck Protection Program (“PPP”) and later forgiven. As background, a portion of a PPP loan may be forgiven provided that loan proceeds are used for qualifying expenses within a qualifying period. Further, Section 1106(i) of the CARES Act states: “For purposes of the Internal Revenue Code of 1986, any amount which (but for this sub-section) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.” In other words, Congress specifically excluded PPP loan forgiveness amounts from a taxpayer’s gross income (which forgiveness amount, if Congress had not included Section 1106(i), would likely constitute income from the cancellation of indebtedness under general income tax principles).
Had Congress remained silent in regard to the tax-free nature of loan forgiveness, the overall effect to taxpayers (in most cases) would be neutral because expenses paid with PPP loan proceeds would be deducted, and offset, any such income. Notice 2020-32, however, clarifies that ‘no deduction is allowed for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to the CARES ACT and the income associated with the forgiveness is excluded from gross income for tax purposes.’
While the tax analysis presented by Notice 2020-32 is reflective of general income tax principles and consistent with the principles of Section 265 of the Internal Revenue Code, the Notice may conflict with Congressional intent reflected in the CARES Act. Based on the express language of the CARES Act, it appears Congress included Section 1106(i) to make loan forgiveness tax favorable to taxpayers as opposed to tax neutral (which would result if Notice 2020-32 is applied in its current form). To achieve this intention in application and be taxpayer ‘favorable’, Section 1106(i) would require both (1) exemption of loan forgiveness amounts from gross income; and (2) the permitted deduction of otherwise deductible expenses paid with PPP loan proceeds (regardless of whether such proceeds are later forgiven).
For additional information, or with specific questions, please contact any member of the Katz Teller Tax Group.