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IRS Clarifies Position on Forgiven PPP Loan Expenses – Not Deductible

The Coronavirus Aid, Relief and Economic Security (CARES) Act passed in March 2020 included the Paycheck Protection Program (“PPP”), which provided small businesses with funds to pay certain business expenses, including payroll costs and benefits, interest on mortgages, rent and utilities. In addition, that Act provides for loan forgiveness of all or a portion of the PPP loan based on the use of the funds by the loan recipient. It stipulates that, for federal income tax purposes, the amount of loan forgiveness shall be excluded from gross income.

Unfortunately, the statute did not address the issue of the federal income tax treatment of deductibility of the expenses paid with proceeds from PPP loans that have or will be forgiven. However, in May 2020, the IRS published guidance (Notice 2020-32) that indicated that the expenses paid with proceeds from PPP loans that were forgiven were not deductible for federal income tax purposes. We addressed this issue in a prior tax blog - https://www.herbein.com/blog/internal-revenue-service-no-deductions-for-ppp-loan-forgiveness.

Controversy with businesses and tax advisers
The IRS position in Notice 2020-32 caused considerable controversy with business owners and tax advisers. Some believe that disallowing the deductions related to the forgiven PPP loans would actually treat the loan forgiveness as being taxable income which seems contrary to the intent and spirit of the CARES Act. Other commentators suggest that disallowance of the deductions is simply tax neutrality.

In addition, there was uncertainty regarding the status of the deductibility of the related expenses if the business did not yet know if its PPP loan would be forgiven.

Current IRS guidance
On November 18, the IRS published additional guidance regarding this matter (Revenue Ruling 2020-27 and Revenue Procedure 2020-51).

The IRS clarified its position that business expenses paid with proceeds from PPP loans that are or may be forgiven are not deductible. This is the case regardless of whether the business applied for PPP loan forgiveness in 2020 and will not know if the loan is forgiven by year end OR if the business has not yet applied for loan forgiveness but plans to do so in 2021.

Potential legislative solution
It is worth noting that while this is the current position of the IRS, there is bi-partisan support for legislation that would stipulate that the expenses related to forgiven PPP loans are deductible. However, it is uncertain if or when such legislation may be passed. Therefore, for now it appears that if a business reasonably expects some or all of its PPP loan to be forgiven, then the business expenses related to those forgiven loan proceeds will be considered NOT DEDUCTIBLE.

We will provide further updates on this important topic as soon as they become available. For additional information contact us at info@herbein.com