While the the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) specifically provides that any portion of a Paycheck Protection Program (PPP) loan that is forgiven is excluded from income, the IRS recently provided guidance that business expenses used to obtain forgiveness of a PPP loan are not deductible (see IRS Notice 2020-32).
A business that uses the proceeds of a PPP loan to pay certain expenses (including payroll, rent, etc.) during the 8 week period following the loan origination date is forgiven from paying back such loan provided that the business does not reduce its workforce and uses at least 75% of the loan proceeds on payroll costs.
While Section 1106(i) of the CARES Act specifically provides that the amount of the loan which is forgiven shall be excluded from gross income, the Act does not address the deductibility of such expenses.
Practically, speaking this means that a business will have to pay income tax on the proceeds of a PPP loan. Consider the following simple example:
- A business obtains a PPP loan in the amount of $25,000.
- During the 8-week period following the date of a PPP loan, a business has $100,000 of gross income from its business operations with $50,000 in non-payroll costs and $25,000 payroll costs.
- The business uses 100% of the proceeds of the loan on payroll costs and the loan is forgiven.
- If the payroll costs are deductible, the businesswould report net income of $25,000 ($100k less $75k)
- IF the payroll costs are not deductible, the businesswill report $50,000 of income ($100k less $50k) so its taxable income is effectively increased by the amount of the PPP loan.
Many commentators and industry groups have expressed concern that the position of the IRS undermines the law’s objective that a forgiven PPP loan not result in taxable income to the business. This week, legislation was introduced in the Senate that would overrule the IRS notice and clarify that ordinary expenses funded by PPP loans are deductible (Senate Bill S.3612).