The IRS released guidance (Notice 2020-32) to explain that a taxpayer that receives a loan through the Paycheck Protection Program (PPP) is not permitted to deduct expenses that are normally deductible under the Code, to the extent the expenses were reimbursed by a PPP loan that was then forgiven. The PPP was created by Section 1106 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136. Under Section 1106(b) of the CARES Act, an eligible recipient of a covered loan can receive forgiveness of indebtedness on the loan in an amount equal to the sum of payments made for the following expenses during the eight-week covered period beginning on the covered loan's origination date: (1) payroll costs; (2) any payment of interest on any covered mortgage obligation; (3) any payment on any covered rent obligation; and (4) any covered utility payment. Section 1106(i) excludes from gross income any amount forgiven under the PPP.
The notice explains that, although the expenses paid by the PPP may be deductible under Sec. 162 as trade or business expenses or under Sec. 163 as interest, Sec. 265 disallows a deduction to a taxpayer for any amount otherwise allowable as a deduction to the taxpayer that is allocable to one or more classes of income other than interest (whether or not any amount of income of that class or classes is received or accrued) that is wholly exempt from the taxes imposed by Subtitle A of the Code. The purpose of Sec. 265 is to prevent a double benefit by preventing a deduction for excluded income.
According to the IRS, Sec. 265(a)(1) prohibits an otherwise allowable deduction under any provision of the Code, including Secs. 162 and 163, for the amount of any payment of an eligible Section 1106 expense to the extent of the resulting covered loan forgiveness (up to the aggregate amount forgiven) because that payment is allocable to tax-exempt income. This is consistent with the purpose of Sec. 265 to prevent a double tax benefit. The IRS cited Rev. Rul. 83-3 for the proposition that deductions must be decreased to the extent the associated expense is allocable to amounts excludable from gross income.
The CARES Act itself does not address whether deductions otherwise allowable under the Code for payments of eligible Section 1106 expenses by a recipient of a covered loan are allowed if the covered loan is subsequently forgiven as a result of the payment of those expenses.
The AICPA believes strongly that the IRS's interpretation denying deductions of expenses forgiven under the PPP program is contrary to Congress's intent. Chris Hesse, CPA, chair of the AICPA Tax Executive Committee, said: "In effect, the IRS guidance means that the taxability provision [Section 1106(i)] has no meaning. Why waste the ink to say that for purposes of the Code, the loan forgiveness is not includible in income, if the government will just take away deductions in the same amount?"
Because it believes the intent of the CARES Act was to allow businesses to deduct all of their ordinary and necessary expenses — including any expenses used in determining PPP covered costs — the AICPA plans to seek legislative clarification.