Deductibility of expenses paid with the proceeds of the canceled PPP loan | McCarter & English, LLP
On April 30, 2020, the Internal Revenue Service (the “IRS”) issued Notice 2020-32. The notice sets out the IRS’s position that no deductions are allowed for federal income tax purposes for any expense paid with loan proceeds received and canceled under the Check Protection Program. payroll (“PPP”), provided for by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The Opinion has been criticized by members of both houses of Congress, and there appears to be bipartisan support for enacting legislation that will overturn it.
As a background (discussed in more detail here), the PPP was established by the CARES Act to provide loans to qualifying small and medium-sized businesses in order to maintain payroll (including benefits), rehire employees who have been made redundant, and cover applicable overhead costs, such as mortgages, rent and utilities. Under the PPP, a beneficiary of such a loan can use the proceeds to pay, inter alia: certain “labor costs”, as detailed here; interest on mortgage bonds; to rent; public services; and interest on other debt obligations (collectively, “covered expenses”). For the purposes of a PPP loan, “labor costs” include: compensation of employees, including salary, wages, commissions or similar compensation; tips in cash or the equivalent; payment of vacation, parental, family, medical or sick leave; severance or severance pay; payment of employee benefits, including health care coverage and group insurance premiums; retirement benefits; and the payment of national and local taxes assessed on the remuneration of an employee.
One of the main features of PPP is loan cancellation, whereby a beneficiary of a PPP loan can, subject to meeting specific requirements of the CARES Act, be exempted from repaying up to the full amount. amount of that loan, including principal and interest, if the loan proceeds are used to pay covered expenses incurred over a period of eight weeks generally beginning on the date of inception of the PPP loan. Generally, federal income tax law requires that the amount of a forgiven debt be recorded as gross income. For federal income tax purposes, the CARES Act specifically excludes from the gross income of a beneficiary of any PPP loan the amount of the proceeds of the canceled PPP loan.
As a general rule, the federal income tax law allows a tax deduction for all ordinary and necessary business expenses paid or incurred during the tax year in carrying on a business or business. business. However, a taxpayer generally cannot claim a tax deduction in respect of an otherwise tax deductible expense when the expense is paid using tax-exempt income. The opinion recognizes that the covered expenses are typical business or commercial expenses for which a tax deduction is generally appropriate, but concludes that because the CARES Act excludes from gross income any PPP loan proceeds that are canceled, that income is income. tax exempt and the covered expenses are not deductible. Because of this position, the IRS essentially denies a benefit conferred by the CARES Act: although the company does not recognize the additional income resulting from the cancellation of the loan, it loses the deduction related to salary costs and other expenses paid. with the proceeds of the PPP loan.
As we noted earlier, the IRS ‘position in the Opinion has been the subject of significant criticism from some lawmakers. For example, in a bipartisan letter to Treasury Secretary Steve Mnuchin dated May 5, 2020, Senator Chuck Grassley (R-IA), Senator Ron Wyden (D-OR) and Congressman Richard E. Neal (D- MA) said Congress “did not intend to deny the deductibility of ordinary and necessary business expenses.” The next day, May 6, 2020, Senator Grassley, Senator Wyden, Senator John Cornyn (R-TX), Senator Marco Rubio (R-FL) and Congressman Tom Carper (D-DE) presented the Small Business Expense Protection Act. to clarify that expenses paid with a canceled PPP loan are tax deductible. Congresswoman Lizzie Fletcher (R-TX) announced that she would also introduce legislation to ensure that employers with canceled PPP loans are entitled to a deduction for wages and other expenses paid during the loan period.
It remains to be seen whether bipartisan support from Congress will provide taxpayers with legislative relief from the positions set out in the notice. Nonetheless, we suggest taxpayers who have received a PPP loan to continue to monitor this development and, before filing their 2020 tax return, consult their tax advisor to determine whether legislative relief has been enacted and, in the process. otherwise, if there are opportunities. to challenge the IRS ‘position in the notice. We will update this alert as this rapidly evolving situation continues to unfold.