On Thursday, April 30, the IRS issued Notice 2020-32 clarifying that to the extent a Paycheck Protection Program (PPP) loan is forgiven, the associated expenses will be nondeductible for federal tax purposes. The CARES Act made it clear that any amount of forgiveness of a PPP loan would be non-taxable. What was not addressed and left for interpretation was whether the associated expenses would be tax-deductible. Many were hopeful for a better ruling from the IRS and have already expressed disappointment that this ruling is inconsistent with the intent of the CARES Act. The IRS applied the general rules for the deductibility of expenses associated with tax-exempt income. They may have felt that the CARES Act did not authorize them to deviate from the existing law on expenses associated with tax-exempt income.
A few items to point out:
- In order for a PPP loan to be forgiven the proceeds must be spent on payroll costs and other qualifying expenditures. Therefore, the nondeductible portion should be identical to the amount of loan forgiveness.
- Since the tax-exempt income and nondeductible expenses are the same, for tax purposes this is technically a wash, however, some businesses may be surprised to find out they end up in a taxpaying position. It is therefore important to consider the tax implications once a business knows the amount of PPP loan forgiveness.
- Also, for S-Corporations and partnerships, a shareholder’s or partner’s tax basis should not be impacted since tax-exempt income (i.e. the loan forgiveness) increases basis and nondeductible expenses (i.e. the associated expenditures) decreases basis.
- It is unlikely that the states will take a differing position on this.
We will continue to monitor this situation to see if Congress can or will compel the IRS to reverse this position or potentially change this to a more favorable outcome through additional legislation.