IRS Regulations Are at Odds with CARES Act Regarding Taxability of Paycheck Protection LoansMay 4, 2020 – Legal Alerts
The IRS has issued Notice 2020-32 addressing the ability to deduct expenses paid with proceeds of Paycheck Protection Program loans.
Under Section 1102 of the CARES Act, qualifying businesses are eligible for Small Business Administration Paycheck Protection loans of up to 2.5 times their average monthly payroll, calculated as defined in the Act. Section 1106 of the CARES Act provides that such loans shall be forgiven, subject to certain eligibility requirements, in an amount equal to qualifying expenditures (payroll, interest, utility, and certain other expenses) paid or incurred by that business during “the eight-week period beginning on the date of the origination of a covered loan.”
Generally, the forgiveness of indebtedness is taxable income to a taxpayer whose debt is forgiven in an amount equal to such forgiveness in Section 108 of the Internal Revenue Code of 1986 (“Code”). However, the CARES Act, in Section 1106(i), provides that for purposes of the Internal Revenue Code, any amount which “would be includible in gross income of the eligible recipient by reason of [such] forgiveness … shall be excluded from gross income.” This provision was intended to provide a benefit to the borrowing business by allowing the full amount the loan to be used for qualifying costs. However, what the CARES Act provided in this regard, the IRS appears to have taken away in IRS Notice 2020-32. Citing Section 265(a)(1) of the Code, which disallows any deduction if “allocable to one or more classes of income … wholly exempt from the taxes imposed by this subtitle,” this Notice concludes that the expenses paid with the Paycheck Protection loan, which is forgiven, are not deductible. This treatment effectively puts the taxpayer in the same position, as if the forgiveness of the loan were fully taxable. As this seems counter to the intent of Congress under the CARES Act, hopefully the IRS will reconsider this position. It is our understanding that House Ways and Means Committee Chair Richard Neal has stated his intent to explicitly make the expenses funded with small business loans tax deductible in the next COVID-19 response legislation, a sentiment, we understand, is shared by Senate Finance Committee Chair Chuck Grassley.
“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 in a statement. “This notice is contrary to that intent.”