ComplianceMay 04, 2020

IRS Notice 2020-32 disallows small business expenses if funded by PPP loans and forgiven

The CARES Act (Pub. L. No. 116-136) enacted the Paycheck Protection Program (PPP). The law includes noteworthy borrower tax relief relating to PPP loan forgiveness. Generally, the forgiveness or cancellation of indebtedness can give rise to taxable income to the borrower whose debt is forgiven or cancelled under federal income tax law pursuant to Section 108(e) of the Internal Revenue Code, unless a specific exception applies. The CARES Act, however, provides a special exception from this general rule for PPP loans forgiven under these special rules and exempts “any amount which … would be includible in gross income of the eligible recipient by reason of forgiveness.”

IRS Notice 2020-32, released on April 30, 2020, addressed a related tax issue. Ordinarily, a small business’s expenses for payroll, mortgage interest, rent and utilities are generally deductible business expenses for federal income tax purposes. All or a portion of eight weeks of qualifying expenses of these type may be funded from PPP loan proceeds that a small business receives, and, all or a portion of these expenses may qualify for PPP loan forgiveness and would be excludible from taxable income. Conversely, Sec. 265 of the Internal Revenue Code provides, in part, that no tax deduction is allowed for expenses where “[a]ny amount otherwise allowable as a deduction which is allocable to one or more classes of income other than interest (whether or not any amount of income of that class or classes is received or accrued) wholly exempt from the taxes imposed by this subtitle...” The CARES Act does not explicitly deny these deductions, but the language of Sec. 265 is broad. Some tax practitioners have raised concerns that expenses funded out of loan proceeds (where it is known in the same tax year as the expense that the obligation to repay such proceeds is forgiven) are not deductible for federal income tax purposes because of Sec. 265. Focusing on Sec. 265, the IRS guidance in Notice 2020-32 “clarifies that no deduction is allowed under the Internal Revenue Code (Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness…” of a PPP loan.

This Insight is an excerpt from a longer article on PPP loan forgiveness.

Ms. Conlon gratefully acknowledges the contributions of Wolters Kluwer Consulting Manager Neal Doherty, J.D.

DISCLAIMER: The information and views set forth in this Wolters Kluwer Financial Services’ communication are general in nature and are not intended as legal or professional advice. Although based on the law and information available as of the date of publication, general assumptions have been made by Wolters Kluwer Financial Services that may not take into account potentially important considerations to specific businesses. Therefore, the views and information presented in this Wolters Kluwer Financial Services’ communication may not be appropriate for you. Readers must also independently analyze and consider the consequences of subsequent developments and/or other events. Readers must always make their own determinations in light of their specific circumstances.

Stevie Conlon
Vice President, Tax & Regulatory Counsel: Investment Compliance; U.S. Advisory Services

Stevie D. Conlon, vice president, tax and regulatory counsel for Wolters Kluwer leads the firm’s U.S. Advisory Services group and Investment Compliance Solutions.

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