Debating the Deductibility of the Payroll Protection Program (PPP)
Congress Planning Expense Deduction Solution
Last week, the IRS issued guidance on the deductibility of expenses paid using PPP loan funds. According to Notice 2020-32, the extent to which the income resulting from loan forgiveness under the PPP is excluded from income, it’s considered a “class of exempt income” under code section 265. As a result, normally deductible expenses such as wages, interest expense, and rent payments paid with forgivable PPP loan funds are not deductible, essentially preventing a double tax benefit.
Senate Finance Committee Chair Chuck Grassley, R-Iowa, said in a statement, “This notice is contrary to [congressional] intent.”
The American Institute of CPAs (AICPA) also disagrees, arguing that “the CARES Act itself does not address whether deductions otherwise allowable under the Code … are allowed if the covered loan is subsequently forgiven as a result of the payment of those expenses.” Their position is that the IRS’s interpretation disallowing deductions goes against the intent of Congress, and they have asked the IRS for clarification.
You can expect further clarification on this issue to come from Congress in the next COVID-19 relief legislation.
Using the PPP Loan: A Summary
The Paycheck Protection Program loan, enacted into law through the CARES Act, currently contains two rounds of funding at $349 billion and $310 billion to help small businesses maintain payroll and other necessary expenses during the coronavirus pandemic. Certain payroll costs, mortgage interest, rent, and utilities are forgivable expenses within the loan’s first eight weeks of disbursement. Payments on the remaining balance of your loan that is not forgiven, including principal and interest, are deferred for at least six months. The amount of the PPP loan that is forgiven is not considered a cancellation of debt income for federal income tax purposes.
Small businesses that received a PPP loan to help cover the costs of payroll and other expenses before June 30 have faced numerous challenges already, and this is one more provision to consider.
Ordinarily Deductible Expenses
Under normal circumstances, the IRS permits businesses to deduct from gross taxable income all “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” These deductible expenses typically include:
- Utility payments
- Salaries and other compensation
- Debt interest paid or accrued, including mortgage interest
- Employer portion of health insurance costs
- Employer portion of retirement contributions
While we wait for further guidance to be issued, it remains unclear how allowable deductions would be treated if the amount of PPP loan forgiveness is reduced. It will depend on how such expenses are allocated to the tax-exempt income incurred as a result of forgivable PPP loan proceeds.
In any case, PPP loan recipients need to be clearly documenting how funds are being used. Over-documentation in this situation will be better than under-documentation when it comes time to file your 2020 tax return.
There is no uniform guidance yet on documentation, but Adams Brown Senior Manager James Bailey provided some guidance in a recent webinar, which you can read about and view here.