Deduction of PPP Expenses

When Congress passed the CARES Act, one of the most talked-about provisions was the Paycheck Protection Program or PPP for short.  This provision provides low-interest loans for businesses to help them continue to keep people working and ride out the COVID-19 lockdown.  To date, banks have issued over a half-trillion dollars of these forgivable loans.

In most cases, taxpayers will also be able to apply to have these loans forgiven by proving that they spent the money on payroll and other specified business expenses. The law also provides that when the loans are forgiven, they are exempt from income tax, even though the tax law typically taxes loan forgiveness.  Free money – what a great deal!  But let's not get ahead of ourselves.

The IRS, which is not known for its generosity, then issued Notice 2020-32, which reminded people that any expenses allocated to tax-exempt income are not deductible.  That means that taxpayers cannot write off any of the expenses that were paid with the forgiven funds. The effect of this is to make the forgiven loan proceeds taxable after all.

Congress clearly intended these funds to be non-taxable, but the IRS points out, in effect, that if that is what they wanted to accomplish, they didn't write the law correctly.

As a result, taxpayers are now stuck in a battle between the IRS and Congress.  When it comes time to file their 2020 returns, should they deduct the expenses as Congress intended and potentially expose themselves to an unwelcome bill for unpaid tax, interest, and penalties?  Or do they follow the IRS pronouncement, ignore Congress' intent, and not deduct the expenses, thus paying taxes on the amount forgiven?

Tax commentators disagree as to what the right answer is.  Unless and until Congress settles the issue with a new law, the conservative route would be to not deduct the expenses for now and amend the return later if Congress acts.  We can only hope that Congress will give us the fix we need to safely deduct the expenses.

Contributed By: Mark Westerhausen, CPA  | Tax Director | DWD CPAs & Advisors