Under the CARES Act, Payroll Protection Loan (PPL) funds that are forgiven are tax-exempt income. Normally, the allowed expenses on which PPL funds are required to be spent (i.e. cash compensation, health care and retirement benefit costs, rent, interest and utilities) are deductible for income tax purposes.
However, in Notice 2020-32, the IRS ruled that the payment of allowed expenses funded by forgiven PPL funds are not tax-deductible. In this notice, the IRS explained that disallowing the deductibility of these expenses “prevents a double tax benefit.”
This issue arose because of the unprecedented nature of PPP forgiveness being tax exempt income. Under many circumstances, forgiven debt is treated as taxable income, avoiding this double tax benefit with respect to debt proceeds being used to fund expenses. In certain circumstances, the forgiveness is not taxable but may require the reduction of tax attributes such as net operating losses.
Some Senators and Congressmen are pushing back on this IRS ruling. Their position is that forgiven PPL-funded expenses should be tax deductible, disagreeing with the IRS.
Senate Finance Chairman Chuck Grassley stated, “The intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible. This notice is contrary to that intent.”
House, Ways and Means Committee Chair Richard E. Neal, D-Mass., announced with his spokesperson Erin Hatch, “We are planning to fix this in the next response legislation.”
It is clear Congress will take up legislation to reverse the IRS’s ruling in Notice 2020-32, but only time will tell if this legislation is enacted.
If you have any questions about the impact of PPP forgiveness on the deductibility of your business expenses, please contact your Grassi tax advisor.