IRS Clarifies Deductibility of PPP Loan Covered Expenses
If you have operating expenses covered under a PPP loan in 2020, take care in considering your deductions for 2020 tax planning. The IRS has issued guidance to avoid deducting any expenses paid for with potentially tax-exempt (forgivable) income.
A recent IRS Notice (2020-32) clarified that expenses covered by Paycheck Protection Program forgivable loan funds would not be deductible under the Small Business Act (15 U.S.C. 636(a)(36)), section 7(a)(36) if the payment of such expenses result in forgiveness of the PPP loan.
Under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136, 134 Stat. 281, 286-93 (March 27, 2020), the income associated with the forgiveness is excluded from gross income for purposes of the Code pursuant to section 1106(i) of the CARES Act. Therefore, deducting otherwise eligible expenses that are paid for by exempt income would constitute a “double tax benefit,” according to IRS notice.
In its simplest terms, if your business receives a $100,000 PPP loan and uses the funds to cover $100,000 of qualified expenses — and the loan is fully excluded from taxable income because it is forgiven, your business could not deduct that $100,000 in otherwise eligible expenses on your tax return.
However, if only part of your loan is forgiven and some funds are reported as taxable income, then there may be some deductibility of covered expenses up to the aggregate loan amount forgiven. Covered deductible expenses, in this case, includes those identified as payable with PPP loan proceeds:
- payroll costs
- certain employee benefits relating to healthcare
- interest on mortgage obligations
- interest on any other existing debt obligations
As part of tax planning, any businesses receiving PPP loans in 2020 will need to identify the percentage of normally deductible operating expenses paid or incurred during the taxable year of carrying on a trade or business (Section 162) that were covered by PPP loan funds. Whether loan is forgiven in full or in part, additional calculations will be necessary to report the correct amounts of deductible expenses on your 2020 tax return.
For any questions about documenting PPP loan fund use and coverage of operating expenses, talk to your CPA at DS+B. You may also be interested in our blog post on other key provisions for businesses and individuals under the CARES Act.