One of the things that makes the Payroll Protection Program so attractive is that if a borrower spends its loan proceeds properly (on items such as payroll, rent and utilities), the loan will be forgiven. Furthermore, Section 1106(i) of the CARES Act, provides that the forgiven loans are excluded from gross income, which means that the borrower receives the loan amount (without a repayment obligation) entirely tax-free.
But, what about the tax deduction that would ordinarily apply to those business expenditures made in order to obtain loan forgiveness? According to a recent memo from my colleagues at Calfee, there’s a limit to Uncle Sam’s generosity:
The question arises because Section 265 of the Internal Revenue Code provides that a taxpayer cannot take tax deductions, even if otherwise allowable, if the deductions are allocable to income that is exempt from tax. The general purpose of Section 265 is to prevent taxpayers from enjoying a “double” tax benefit (i.e., tax-exempt income generating tax deductions).
In Notice 2020-32, released today, the IRS clarifies that Section 265 does in fact apply to PPP loans and prevents taxpayers from deducting expenses that lead to forgiveness under the CARES Act. This interpretation will have the effect of negating much (if not all) of the tax benefit Congress provided with the exclusion under Section 1106(i). Given the larger goal of Congress to inject cash into struggling businesses, this result had some wondering (before today) whether the IRS would apply Section 265 to PPP loan forgiveness.
-John Jenkins, TheCorporateCounsel.net May 4, 2020
