IRS Decides that PPP Forgiven Loans Used for Qualifying Expenses Are Not Deductible

by | May 5, 2020

In the weeks since the enactment of the CARES Act and implementation of the Paycheck Protection Program – a forgivable loan program designed to assist small businesses to retain employees – many questions have been raised regarding the resulting tax consequences and implications to small businesses participating in the program. 

The CARES Act makes clear that PPP loans used for payroll and other qualifying expenses may be forgiven in whole or in part if the business retains or rehires a minimum percentage of its employees and uses at least 75% of the funds for payroll costs.  The CARES Act also provides that the portion of any PPP loan forgiven in accordance with the program “shall be excluded from gross income” for federal income tax purposes. See CARES Act, § 1106(b).  Ordinarily, discharge of indebtedness is considered to be income, and therefore subject to federal income taxation.

While the CARES Act is clear that loans properly forgiven under the PPP should not be included as “gross income,” the legislation does not speak to whether PPP loans used to pay qualifying expenses, such as payroll, utilities, and rent, can still be deducted as ordinary and necessary business expenses if the loan amounts used to cover these expenses are subsequently forgiven.

Last week, the IRS published an Advanced Notice setting forth its position that PPP loan proceeds used for payroll, utilities, rent and other qualifying expenses are not deductible business expenses if the loan amounts are forgiven.  According to the IRS, allowing businesses to exclude forgiven loans from “gross income” while also permitting businesses to deduct such amounts for federal income tax purposes would create a “double tax benefit” or windfall.

The IRS’ Advance Notice outlines the legal and practical basis underpinning its position; however, the IRS does not explain why the CARES Act expressly excludes PPP loan forgiveness from the definition of “gross income,” but includes no corresponding provisions disallowing otherwise deductible expenses for payroll, rent and utilities made with loans subsequently forgiven.  The IRS’ interpretation appears largely designed to prevent a “double tax benefit” without considering whether that is precisely what Congress intended the CARES Act to provide.

For now, the IRS’ view seems likely to stand, unless and until Congress passes supplemental legislation addressing the issue. 

We are committed to assisting our clients and will provide updates as more information becomes available. Please contact Matt Tyrrell (312-648-2300) with any questions you may have.