The global COVID-19 pandemic has caused innumerable problems for many individuals and businesses. In an effort to ease some of the economic problems, Congress passed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, a critical part of which was the Paycheck Protection Program (“PPP”). Under the PPP, a qualified and eligible business could obtain a loan for use to pay (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. While the PPP loan itself was a great benefit for many, it also had a key forgiveness characteristic. More specifically, under certain terms, a recipient of a covered PPP loan can receive forgiveness of indebtedness on the loan in an amount equal to the payments made for qualified and eligible expenses within a specific period of time.
In usual circumstances, when a loan is forgiven, it causes a taxable event. Known as cancellation of debt income (“CODI”), the law sees an increase in your wealth when you are discharged of the reciprocal obligation to repay a debt; hence, the amount is treated as taxable income. There are, however, some limitations to CODI under the law already. But if IRC § 108 does not apply, a taxpayer who received cancellation of debt my be in for an unwelcome surprise.
This was not a desired result given the sensitive economic pressures placed on PPP loan recipients. Therefore, Congress excluded forgiveness of PPP loans from taxable income as part of the CARES Act. Although this is a great result for deserving taxpayers, it immediately raised questions about how to treat the deductibility of expenses paid with PPP loan funds.
In Notice 2020-32, the IRS has taken the position that no deduction is allowed for an expense that is otherwise deductible because IRC § 265 denies deductions from income of a class that is exempt from tax. Many have noted that this interpretation seems reasonable (i.e., a taxpayer should not have a double benefit of no taxation on the CODI but full deductions from the use of the funds), some members of Congress and other commentators disagree. This disagreement stems in part from the old tax axiom, “deductions are a matter of legislative grace.”
Tax year 2020 returns (which won’t be filed for many more months, and won’t be audited for even more months thereafter) are set for considerable confusion. Without further guidance taxpayers and their advisors are likely to struggle greatly with these and other PPP loan issues.
McLaughlin Legal, APC is a tax law firm with a special focus on tax litigation and controversies. If you have questions or issues related to PPP loan forgiveness or deductions based on loaned funds, please do not hesitate to contact us.