May 6, 2020
On April 30, 2020 the IRS issued Notice 2020-32 (the “IRS Notice”) clarifying that no deduction is allowed under the Internal Revenue Code (the “Code”) for expenses that are otherwise deductible under the Code if the payment of the expenses were made with funds from the Paycheck Protection Program (“PPP”), and the income associated with the forgiveness of the loan under the PPP is excluded from income by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”).
In general, under the Code, a taxpayer that receives a loan recognizes income if they ultimately do not pay the loan back, typically referred to as cancelation of indebtedness income, or “COD income”. Under the CARES Act, businesses that receive a loan under the PPP do not have to pay back the loan to the extent that the loan is used for an eight week period to cover payroll costs, rent, utilities or interest on a mortgage. The CARES Act further provides that loan amounts forgiven under the PPP are excluded from gross income and will not be COD income.
The IRS Notice provides that although the above-mentioned expenses are generally deductible under certain sections of the Code, they are disallowed as deductions by Section 265 of the Code, related case law and IRS Revenue Ruling 83-3, since they would be providing taxpayers with a double tax benefit—a deduction for the expenses, and an exclusion from COD income under the CARES Act.
The IRS Notice, however, appears to conflict with the intent of the CARES Act to provide liquidity to recipients of loans under the PPP. The denial of a deduction for payroll, rent, utilities and mortgage interest paid with loans from the PPP that are then excluded from income results in the recipient of a loan under the PPP being in the same position as if the taxpayer were allowed to take the deduction, but had to recognize the forgiveness of the loan as COD income. Referring to loans under the PPP, Senator Charles Grassley of Iowa has already stated that “[t]he 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.” It has been reported that Congress might override the IRS Notice with legislation to allow deductions for the above-mentioned expenses paid with loans under the PPP. Moses & Singer will continue to monitor this issue, and will provide a further alert to the extent there are any changes or further developments.