PPP Loan Forgiveness Results in Non-Deductible Expenses

The IRS has released guidance about the deductibility of expenses for taxpayers who receive loans under the Paycheck Protection Program (PPP).  While the CARES Act (P.L. 116-136) provided for tax-exempt treatment of the amount of loans forgiven, it did not address whether deductions for expenses associated with the loan forgiveness would still be allowed.

The PPP allows a recipient to use loan proceeds to pay payroll costs, certain employee healthcare benefits, mortgage interest, rent, utilities, and loan interest.  The loan recipient can then receive loan forgiveness for amounts paid during the eight-week covered period beginning on the loan’s origination date for payroll costs, mortgage interest, rent, and utilities, subject to reduction if the average number of full-time-equivalent employees is reduced.

IRS Notice 2020-32 provides a reminder that the Internal Revenue Code does not allow for a deduction of the amount of expenses that are allocable to tax-exempt income.  This also applies to tax-exempt income that is earmarked for a specific purpose and the deductions that are incurred in carrying out that purpose.  The interrelation between the amount of tax-exempt income from forgiveness of a PPP loan and the amounts paid for eligible expenses is sufficient to disallow deduction of these expenses.

The Notice concludes that the deductibility of payments of eligible expenses that result in the forgiveness of a PPP loan must be disallowed, consistent with the Internal Revenue Code, prior case law, and published rulings.

Thus the net result is the same as if the loan forgiveness was taxable and the expenses were deductible. We believe that this result may not have been the intent of the CARES Act and we understand that certain legislators are calling for a legislative change to reflect the original intent.  We will be monitoring this and will update you as events warrant.