PPP and Nondeductibility of Expenses
From SLMA’s tax counsel at Gomel, Davis & Watson, LLP:
Latest News on Paycheck Protection Program
May 5, 2020
On April 30, the Internal Revenue Service issued a notice of its position that expenses paid/incurred with funds borrowed under the SBA Paycheck Protection Program (PPP) and later forgiven would not be deductible. SLMA has consulted with its tax counsel, Gomel, Davis & Watson, LLP, and their thoughts on the latest developments are as follows.
As you may know, a recipient of a PPP loan can have part or all of the loan forgiven, if the borrower can prove that the borrowed funds were used for certain expenses (primarily payroll and rent). As a general rule, forgiveness of debt results in taxable income to the borrower. However, under a specific and fairly unique provision included in the CARES Act, forgiven PPP loans are not included in taxable income.
In response, the IRS announced that expenses that support forgiveness of PPP loans cannot also be deducted on the borrower’s income tax return. The IRS cited Internal Revenue Code Section 265, which generally disallows deductions related to tax-exempt income. Arguably, this treatment prevents a “double tax benefit.”
The CARES Act did not address this specific issue, although one could contend that the intent of Congress in making the forgiveness non-taxable would be thwarted by disallowing the related deductions.
On May 4, Treasury Secretary Steven Mnuchin defended the IRS position. In an interview on the Fox Business Network's "Mornings with Maria", he said that "the guidance is correct…The money coming in the PPP is not taxable. So if the money that's coming is not taxable, you can't double dip…You can't say you're going to get deductions for workers that you didn't pay for."
This treatment effectively puts the borrower in the same position as if the forgiveness of the loan were fully taxable. While this approach may be appropriate in normal circumstances, it appears in direct contradiction to the intent of Congress under the CARES Act. Why would Congress add such a special benefit, knowing that it would be eviscerated under traditional tax principles?
According to several sources, Senate Finance Committee Chairman Chuck Grassley (R-Iowa) expressed disappointment with the IRS guidance, saying in a statement that the issue was discussed during the development of the program. “The intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible,” Grassley said. “This notice is contrary to that intent.”
Also, it appears that House Ways and Means Committee Chairman Richard Neal (D-Mass.) is in favor of a legislative fix.
We will continue to monitor developments in this important area.
Gomel, Davis & Watson, LLP
(404) 223-5900
2400 Marquis One Tower, 245 Peachtree Center Avenue, N.E.
Atlanta, Georgia 30303-1241
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