In anticipated guidance, on Thursday, April 30 the IRS issued Notice 2020-32 regarding the tax-deductibility of expenses from Paycheck Protection Program (“PPP”) loan proceeds that are subsequently forgiven, as provided under the CARES Act. As background, the CARES Act provides that the PPP loan may be forgiven to the extent the proceeds are used to pay payroll, rent, utilities, and certain other qualifying expenses during the covered period. The Act clearly states that such loan forgiveness is excluded from taxable income. However, this begged the question, which was not addressed in the CARES Act, of the tax deductibility of the underlying expenses. IRS Notice 2020-32 provides clarification and confirms that no tax deduction is allowed for those expenses.
Let’s suppose, for example, that a company receives a $100,000 PPP loan. The company uses the loan proceeds to pay $80,000 in salaries and $20,000 in rent, and the whole loan is forgiven. The income tax treatment is that the loan proceeds are tax-free, but the salary and rent expenses are not tax-deductible. Ultimately, the PPP loan provides the company with financial assistance, but the financial benefit is smaller than it would have been if the salary and rent were tax-deductible.
In its reasoning for this guidance, the IRS references existing tax law that expenses directly related to tax-free income are generally not tax-deductible, under the concept of preventing a double tax benefit. The IRS applies this same logic to the expenses paid from PPP loan proceeds, linking the amount of tax-exempt loan forgiveness income to the otherwise tax-deductible payments for which the loan proceeds were used.
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