According to new guidance issued by the IRS, (Notice 2020-32) expenses paid for with debt that is forgiven will not be tax-deductible. That means that if you received a Paycheck Protection Program (PPP) loan and spent the money on qualifying expenses, and the entire amount of the PPP loan is forgiven, none of those expenses will be deductible.
Congress’s intent in creating the Paycheck Protection Program was to keep American workers paid and employed, as Title 1 of the CARES Act indicates. Congress states that the purpose of the PPP emergency funding is to provide eight weeks of cash flow assistance to small businesses through federally guaranteed loans to employers who maintain their payroll. The intention is for businesses is to use the funds to cover costs such as payroll, paid sick leave, supply chain disruptions, and employee salaries.
The legislation further provides that certain amounts owed on such loans are eligible to be forgiven if the PPP proceeds are spent on certain qualifying expenses, such as payroll costs, mortgage interest, rent, and utilities. Historically, the IRS code dictates that when debt is forgiven, taxable cancellation of indebtedness income is recognized.
However, Congress carved out a special exception in the PPP bill that allows for tax-free forgiveness of the PPP debt as long as the money is spent on qualifying expenses (listed above). The common interpretation of the CARES Act is that its application would not impact the taxable income of small businesses.
There is a history of cases cited in the guidance related to the non-deductible nature of expenses paid for with tax-exempt money. However, we are hopeful that this was not the intent of the PPP legislation. To fix this, Congress could issue legislation indicating that expenses paid for with forgiven PPP loans will be tax-deductible with language to prohibit reference to existing sections of the IRS code regarding non-deductibility. Whether that happens remains to be seen.
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Barnes Dennig COVID-19 Advisory Team Leaders: