In Notice 2020-32Posted on Thursday, April 30, the IRS categorically stated that taxpayers receiving Paycheck Protection Program (“P3”) loans cannot have their cake and eat it, too!
As we discussed in a recent blog post, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), enacted on March 27, 2020, created the PPP under which the Small Business Administration is authorized to grant up to 349 billions of dollars in forgivable loans to small businesses to help them meet the costs of wages, benefits, rent and utility payments. On April 24, 2020, Congress increased the amount of funds available under the PPP to $ 659 billion when the Paycheck Protection Program and the Health Care Enhancement Act were enacted.
The CARES law expressly excludes from gross income any amount remitted under the PPP. The question left unanswered by the CARES Act is whether the waived amounts that were spent by borrowers for otherwise eligible business expenses (i.e., salary costs, rent, utilities, transportation and interest) are deductible under article 162 of the Code.
Advisory 2020-32 quickly points out to taxpayers and tax advisers – not so quickly – that there are no free lunches. Essentially, if the loan is canceled and, due to the CARES Act, a taxpayer does not have debt income cancellation as he / she would otherwise have under section 61 (a) (11) of the Code, the taxpayer will not be able to deduct the business expenses for which he used the proceeds of the canceled loan.
The IRS cites Section 265 of the Code and Treasury regulations promulgated under it to support its conclusion. In its broadest sense, section 265 of the Code tells us that taxpayers are not entitled to deductions attributable to income that is excluded from gross income. It provides in part:
No deduction is allowed for:
Any amount otherwise eligible as a deduction which is attributable to one or more categories of income other than interest (whether or not an amount of income of this category or of these categories is collected or accumulated) entirely exempt from the taxes imposed by this subclause -title, or any other amount otherwise eligible under section 212 (relating to expenses for the production of income) which is attributable to interest (whether or not an amount of such interest is received or accrued) fully exempt from taxes imposed by this subtitle.
The government’s conclusion, from a purely academic point of view, makes sense. Under normal circumstances, taxpayers should not derive a double tax benefit from forgiving debt (that is, a deduction of expenses paid from the loan proceeds and a tax exemption from the forgiven loan). However, we do not live in normal times.
The CARES Act created the PPP to help businesses survive this horrific time and enable them to keep their workforce in place. Granting these companies a double taxation advantage makes perfect sense in this context. When drafting the PPP loan forgiveness provision, Congress chose to create a new loan forgiveness mechanism under the CARES Act, separate from Section 108 of the Code, which already provides for an income exclusion. cancellation of debt income. Congress could have simply amended Section 108 of the Code to wipe out canceled PPP loans under the existing income exclusion. However, he did not follow this path. Congress’s unusual approach to PPP loan forgiveness appears to support the conclusion that it did not consider the application of Section 265 of the Code when it passed the CARES Act and had the Intention that taxpayers receiving PPP loan forgiveness can have and eat their cake too (i.e., tax-exempt loan forgiveness and deductibility of amounts used for otherwise qualifying business expenses).
We suspect that many business owners will be baffled when they learn of Advisory 2020-32. For most taxpayers, their P3 loan, if canceled completely, will cost them 21 to 37 cents for every dollar of federal income tax canceled. On top of that, there will likely be state and local income taxes owed by these taxpayers. Ouch! If this is not provided for, these taxpayers may find themselves unable to pay the resulting taxes.