IRS Clarifies Disallowance of PPP Loan Covered Expenses to the Extent of Loan Forgiveness

May 1, 2020Alerts

Paycheck Protection Program (PPP) Loans authorized under Section 1102 of the CARES Act are intended to provide businesses with additional liquidity to cover (1) payroll costs, (2) certain employee benefits relating to healthcare, (3) interest on mortgage obligations, (4) rent, (5) utilities, and (6) interest on any other existing debt obligations (“covered” expenses).

As described in previous Alerts, to the extent that a business uses PPP Loan proceeds to fund these covered expenses (and maintains its workforce), the indebtedness taken by a business may be forgiven.

Although Section 1106(i) of the CARES Act specifically excludes forgiven PPP Loan proceeds from the business’ taxable income, the Act did not address the deductibility of the covered expenses themselves.

To clarify the deductibility question, the IRS issued Notice 2020-32 on April 30, 2020, which focuses on principles of existing statutory (Code Section 265 dealing with tax-exempt income) and case law (dealing with reimbursed expenses).

The IRS concludes in the Notice that the law “disallows any otherwise allowable deduction under any provision of the Code, including sections 162 and 163, for the amount of any payment of an eligible section 1106 expense to the extent of the resulting covered loan forgiveness (up to the aggregate amount forgiven).”

Therefore, IRS has taken the position that a business that receives PPP Loan forgiveness cannot deduct the covered expenses for which the loan proceeds are utilized, to the extent of the aggregate loan forgiveness.