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Breaking news: IRS issues important guidance that addresses the deductibility of expenses paid from a Paycheck Protection Program loan 

As many of you already know, the Paycheck Protection Program (PPP), established by the CARES  Act [1], is a loan program designed to provide a direct incentive for small businesses to keep their workers on the payroll. Generally, under the PPP, a borrower can receive forgiveness of the debt if the loan proceeds are used for payroll costs, interest on mortgages, rents and utilities, and the employer maintains its employee count and salary levels. The CARES Act provides that if a PPP loan is forgiven, the borrower does not recognize cancellation of indebtedness income. What the CARES Act does not address is whether a borrower will be able to deduct the expenses if they are funded by a PPP loan that is forgiven. 

On April 30, 2020, the IRS stated in Notice 2020-32 that the expenses paid (e.g., payroll costs, interest on mortgages, rents and utilities), which generate the PPP loan forgiveness, cannot be deducted. The IRS said these PPP expenses are not deductible because it would result in an improper double tax benefit. For example, investment expenses incurred in the creation of tax-exempt interest are not deductible. Also, a tax deduction is disallowed where the taxpayer is reimbursed for the expense. Similarly, a tax deduction should not be permitted for payroll expenses where there is no taxable income recognized on the related cancellation of indebtedness.

The inability to deduct expenses that generate forgiveness of a PPP loan should have businesses reconsidering its benefits. If an employer receives a PPP loan, then the employer is not eligible for the Employee Retention Credit (ERC) established by the CARES Act. The ERC is a refundable tax credit against certain employment taxes equal to 50% of up to $10,000 in qualified wages. Borrowers need to confer with their advisors to determine what will be best for their circumstances. 

[1] Coronavirus Aid, Relief, and Economic Security (CARES) Act

Client alert authored by David B. Shiner (312 855 4319), Principal, J.D., LL.M Taxation.

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