The Paycheck Protection Program (PPP) makes loans that can be applied to covering essential costs available to business owners struggling to keep their businesses running effectively during the pandemic. IRS Notice 2020-32 answers a question commonly-asked by PPP borrowers as to whether or not PPP loan expenses paid for with tax-free loan dollars (that may be eligible for loan forgiveness in the future) could also be deductible as business expenses on a borrower’s income tax return.
Forgiveness vs. Deductibility
In general, PPP loans are meant to cover a limited list of expenses including payroll, rents, mortgage interest, and utilities for businesses that might otherwise be forced to close without this assistance. Because these loan expenses have the potential to be forgiven at up to 100% (as long as the business meets certain criteria and the forgiven amounts are not included in the borrower’s gross income), the IRS guidance states that borrowers whose loans are forgiven cannot claim the same expenses that have already been forgiven as deductible on their return.
Under IRS rules, forgiven debt is generally taxed as cancellation of debt income. If the payment of expenses leads to PPP loan forgiveness, IRS Notice 2020-32 states that those loan expenses are not also permitted to be deductible, as allowing for the deduction would be considered a double tax benefit. IRC Sec. 265 disallows a deduction for any amount otherwise allowable as a deduction that’s allocable to tax-exempt income (other than interest). According to the IRS, forgiven PPP loan expenses constitute this type of tax-exempt income.
The result for borrowers is basically an offset of the tax benefit in which the forgiven amounts are excluded from gross income but the deductions for those amounts are eliminated.
Additional Changes May Still Be Coming
Some members of Congress are taking exception with the IRS guidance and are suggesting that forgiven PPP loan expenses should, in fact, be tax-deductible and addressed via additional legislation. We will provide updates should the issue receive additional legislative attention.
If you have questions about PPP loan expenses, forgiveness, or which business expenses are deductible, contact your Untracht Early advisor.