Tax Man Stops Double Dipping for PPP

If you were recently one of the lucky business owners to get your hands on Paycheck Protection Program (PPP) funds and thought you would be able to deduct those expenses used for loan forgiveness, it is time to rethink this. On April 30th, the IRS issued Notice 2020-32 which gives the clarity that we all needed on this issue, just not the kind we were all hoping for.

A recipient of a PPP loan has 8 weeks from the time of funding to use the money for certain covered expenses. These include payroll costs, any payment of interest on any covered mortgage obligations, rent, and utilities. If the PPP loan funds are used for these covered expenses, of which payroll costs have to be 75%, then the loan will be forgiven by the SBA and the proceeds become non-taxable income to the business owner. Previously in the absence of any additional guidance, many were thinking that while the forgiven PPP loan proceeds would be non-taxable per the CARES Act, the expenses would still be deductible allowing additional relief to small business owners – not so says Notice 2020-32.

To get technical with it, the IRS is looking to section 265(a)(1) of the Internal Revenue Code and §1.265-1 of the Income Tax Regulations as it relates to expenses that would be deductible under normal expenses but are incurred for the purpose of earning or otherwise producing tax-exempt income. This usually relates to individuals or businesses that receive tax-exempt income and the expenses incurred in relation to this income. Basically, if you receive free money, you don’t get to then deduct the expenses used to get your hands on or keep the free money (i.e. – tax-exempt bonds, life insurance premiums/proceeds, tax-free grants for teachers).

This basically has small business owners ending up with a net tax effect of $0 which is not a terrible place to be, but it is not as cheerful as being able to have your cake and eat it, too.

How is there net effect of $0 you ask? If a small business has a PPP loan of $25,000 and used various covered expenses of payroll, rent, interest, and utilities to reduce that loan to $0 and have the full $25,000 loan forgiven, then there would be no tax deduction for these expenses used to forgive the loan.

 

PPP Loan Funds Forgiven $25,000 Non-taxable
Covered Payroll ($20,000) Non-deductible
Rent ($3,500) Non-deductible
Interest ($500) Non-deductible
Utilities ($1,000) Non-deductible
Net Tax Effect $0

My personal thought is this is not what Congress intended when they passed the CARES Act. Congress took the time to state the forgiveness of the loan would not be taxable income to business owners but stayed silent about the non-deductibility of the related covered expenses, leaving most of us to believe that there would be an additional benefit to small business owners in this time of need. It seems the AICPA agrees and has already challenged Notice 2002-32 released by the IRS. Regardless of personal thoughts and challenges, we have rules on how we should treat these expenses unless told otherwise. The only way to change this now is to have Congress clarify the legislation…Senator Rubio, we are looking at you…

Find IRS Notice 2002-32 here.