To prevent taxpayers from claiming what the Internal Revenue Service (the IRS) believes to be an unintended double tax benefit under the Paycheck Protection Program (PPP), the IRS issued Notice 2020-32, 2020-21 I.R.B. 1 (the “Notice”) to deny deductions for the payment of expenses resulting in the complete or partial forgiveness of a covered PPP loan. This includes otherwise deductible expenses for certain payroll, mortgage interest, rent and utilities for which Congress provided PPP loans under Section 1106(b) of the Coronavirus, Aid, and Economic Security Act (the “CARES Act”).[1] Accordingly, Congress may now need to act with a legislative fix if it believes that the position of the IRS reflected in the Notice is inconsistent with its legislative intent.
Background
Under the Paycheck Protection Program, the recipient of a covered loan can obtain forgiveness of such loan by an amount equal to the sum of the following expenses paid by the recipient during the eight-week period beginning on the date that the covered loan was originated: (i) payroll expenses, (ii) the payment of rent on leases in force before February 15, 2020, (iii) the payment of interest of mortgage incurred before February 15, 2020, and (iv) utility expenses for which service began before February 15, 2020; provided, that no more than 25% of the forgiven amount can be attributable to non-payroll expenses. However, the amount that can be forgiven is reduced if, during the eight-week period beginning on the date of the origination of the loan, either (i) the average number of full-time employees employed by the recipient is reduced (as compared to the number of full-time employees of the recipient between either (A) February 15, 2019, and June 30, 2019, or (B) January 1, 2020, and February 29, 2020) or (ii) the salary or wages of certain employees are reduced by more than 25% as compared to full quarter immediately preceding the eight-week covered period.
Tax Treatment of Loan Forgiveness & Payments Giving Rise to Loan Forgiveness
Section 1106(i) of the CARES Act specifically states that any amount that would otherwise be included in the gross income of a taxpayer arising from the forgiveness of a loan received under the Paycheck Protection Program as a result of the payment of amounts described in the immediately preceding paragraph shall be excluded from the gross income of the recipient for U.S. federal income tax purposes. [2] Although the CARES Act contains express language disallowing payroll deductions by the amount of the employee retention credits received by an employer under Section 2301 of the CARES Act[3] and the Families First Coronavirus Response Act contains language providing that tax credits received as a result of the payment of sick or family leave are included in the gross income of the recipient,[4] the CARES Act does not specifically address the deductibility of payments that give rise to the forgiveness of a loan received under the Paycheck Protection Program.
The Notice states that Section 265(a)(1) of the Code[5] applies to disallow an otherwise allowable deduction under Section 162 or Section 163 of the Code to the extent that the payment of the expense giving rise to such otherwise allowable deduction resulted in a covered loan received under the Paycheck Protection Program being forgiven pursuant to Section 1106(b) of the CARES Act. The Notice states that this treatment prevents a double tax benefit in a manner consistent with the purpose of Section 265 of the Code and is also consistent with prior IRS guidance addressing the application of Section 265(a) of the Code to otherwise deductible payments.
Conclusion
Although it is unclear whether Congress intended that taxpayers lose a deduction for otherwise allowable deductions to the extent that the payments giving rise to such deductions resulted in the forgiveness of a loan under Section 1106(b) of the CARES Act,[6] Congress may now need to provide a legislative fix to allow such deduction notwithstanding Section 265(a) of the Code if the IRS’s position set forth in the Notice is inconsistent with its legislative intent.
Accordingly, taxpayers receiving loans under the Paycheck Protection Program will need to account for the non-deductibility of covered expenses that result in the forgiveness of a covered loan pursuant to Section 1106(b) of the CARES Act when modeling their post-tax cash flows, particularly if a taxpayer intended to carryback a net operating loss generated or increased by such expenses to a prior year under the five-year net operating loss carryback provided by amendments set forth in the CARES Act.[7]
Footnotes
[View source.]