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Non-deductibility of Expenses Incurred in Connection with PPP Loan Forgiveness

May 1, 2020

by Shaun EisenhauerNicole Stezar Kaylor and Timothy Finnerty

The good news for PPP borrowers is that there is no cancellation of indebtedness taxable income generated by the forgiveness of any of the PPP loan.  The not-so-good news is that on April 30, the IRS issued Notice 2020-32, taking the position that expenses incurred to generate the non-taxable forgiveness are not deductible.  Essentially, a borrower cannot double-dip by (a) receiving untaxed value through receipt of a loan that is ultimately forgiven, while (b) deducting the expenses incurred that generate the forgiveness.  This means that a decision to use proceeds of a PPP loan for “forgivable” reasons should stand on its own economics, without any net tax benefit or detriment.

Under the Paycheck Protection Program (PPP), in general and subject to certain limitations, a borrower may have a portion of its PPP loan forgiven to the extent the loan was used to pay, during the 8-week covered period, (1) payroll costs, (2) interest on certain mortgage obligations, (3) rent pursuant to leases entered into prior to February 15, 2020, and (4) utilities.  In the normal course, these payments would be deductible under IRC Section 162 as ordinary and necessary expenses incurred in carrying on a trade or business or under IRC Section 163 as mortgage interest.  Section 1106 of the CARES Act provides that forgiveness of PPP indebtedness does not create taxable income under IRC Section 61.  However, IRC Section 265 provides that no deduction is allowed for an otherwise deductible expense to the extent that expense is allocable to income exempt from tax.  In essence, the non-taxability of the forgiveness cancels out the deductibility of the expenses giving rise to the forgiveness. (Note that to the extent deductible expenses exceed the forgiveness, those expenses should retain their deductible character).

This update should not be considered in a vacuum.  There are, of course, many other considerations that go into the appropriate use of PPP proceeds.  If you have any questions about the CARES Act or PPP, McNees is here to help.

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