Notice 2020-32: IRS Disallows Deductions Relating To Forgiven PPP Loan Proceeds
The federal income tax consequence of forgiveness of all or a portion of PPP loans has been an outstanding question for some time. Forgiveness of a loan generally results in a business realizing cancellation of indebtedness income under general tax principles; however, the CARES Act expressly provides that any income realized as a result of forgiveness of a PPP loan is excluded from the business’ income.
But this exclusion from discharge of indebtedness income inevitably led to questions about whether payroll and other eligible costs under the PPP would be deductible, for example as ordinary and necessary trade or business expenses under section 162 of the Internal Revenue Code. If the expenses were deductible, the result would be a “double benefit” to the business receiving the forgiveness—an exclusion from income and a deductible expense. If the expenses turned out not to be deductible, any tax benefit attributable to the exclusion from income in the CARES Act would be largely lost to businesses.
The IRS published Notice 2020-32 and ruled that while forgiven PPP amounts will not be includible in income, corresponding business expenses paid with PPP amounts that are forgiven will not be deductible. In support of its position, the IRS cited section 265 of the Code, which provides that no deduction is allowed for amounts allocable to classes of income “wholly exempt” from federal income taxes.
EXAMPLE: Business A receives $1,000,000 of funds pursuant to a PPP loan. Business A expends all $1,000,000 of the PPP funds on qualified payroll expenses (at least 75%), lease payments, and utilities. The PPP loan is then totally forgiven. The discharge of the PPP loan is not includible in income. But the expenditures funded with the $1,000,000 of tax-exempt PPP income is not deductible to Business A.
We believe that the Notice 2020-32 leaves little legal basis to assert deductibility for amounts used to pay business expenses attributable to forgiven PPP loan amounts. Some practitioners believe that the IRS position in Notice 2020-32 defeats the intent to benefit businesses by excluding the PPP forgiveness from income and assert that Congress should consider a technical “fix.” In the meantime, for-profit businesses receiving forgiveness of PPP loans should revise cash flow projections accordingly.