On April 30, 2020, the U.S. Internal Revenue Service (IRS) issued
Notice 2020-32, in which it takes the position that no deduction is allowed under the Internal Revenue Code (Code) for any expense otherwise deductible to the extent that the payment of such expense results in loan forgiveness pursuant to the Paycheck Protection Program (PPP) established by the Coronavirus Aid, Relief and Economic Security Act (CARES Act).
The PPP provides qualifying taxpayers with access to loans, the proceeds of which must be used for certain specific purposes. PPP loans are eligible for forgiveness to the extent certain conditions are satisfied and the proceeds are used to pay certain “covered” expenses. While loan forgiveness generally creates cancellation of debt income included in gross income and taxable under the Code, Section 1106(i) of the CARES Act specifically excludes from gross income any amount that would otherwise be included in gross income by reason of forgiveness of a PPP loan.
The CARES Act does not address the deductibility of payments of “covered” expenses that result in forgiveness of PPP loans, but the “covered” expenses are of a type that generally would be deductible under Sections 162 or 163 of the Code, subject to any applicable limitations.
In Notice 2020-32, the IRS takes the position that Section 265 of the Code prohibits the deduction of expenses that result in PPP loan forgiveness.
1 Section 265 of the Code provides generally that no deduction is allowed to a taxpayer for any amount otherwise deductible to the extent such amount is allocable to income wholly exempt from tax. This rule is intended to prevent taxpayers from obtaining a double benefit by deducting expenses incurred to generate income that is exempt from tax (e.g., interest expense attributable to an investment in obligations generating tax-exempt interest income).
While, as a matter of policy, there is some appeal to the IRS’s position, as it avoids “double dip” scenarios, there is no indication as to whether this was what Congress intended when it included Section 1106(i) in the CARES Act. Certain members of Congress, including the chairman of the Senate Finance Committee (Senator Grassley), have indicated that the IRS’s position is contrary to Congressional intent.
2 Nonetheless, in deciding whether to apply for a PPP loan (or retain the proceeds of any PPP loan previously received), taxpayers should be aware that the IRS has adopted this interpretation.
1 Even if section 265 were not applicable, the IRS asserts that the deductions associated with these expenses would also be subject to disallowance “under case law and published rulings that deny deductions for otherwise deductible payments for which the taxpayer receives reimbursement.”
2 In this regard, it is worth noting that in a similar context involving other COVID-19-related tax benefits, Congress expressly addressed “double dip” concerns. For example, sections 7001 and 7003 of the Families First Coronvirus Relief Act (FFCRA) provide dollar-for-dollar refundable tax credits for wages required to be paid pursuant to the FFCRA’s mandatory sick and family medical leave provisions. Each of those sections includes a “special rule” requiring credits received by an employer to be included in the employer’s gross income, thereby effectively eliminating the benefit of the compensation deduction arising from payment of the covered wages. See FFCRA Sections 7001(e)(1) and 7003(e)(1).
