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Tax Treatment of PPP Loan Forgiveness

On April 30, 2020, the IRS released guidance to clarify one of the key income tax questions that lingered regarding the Paycheck Protection Program (PPP) offered under the Coronavirus Aid, Relief, and Economic Security Act (CARES) Act – whether expenses incurred in connection with the forgiveness of a PPP loan are deductible for federal income tax purposes.

Notice 2020-32 – no deduction allowed for “qualifying costs”

Notice 2020-32 clarified that no deduction is allowed for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the CARES Act. In coming to this conclusion, the IRS points to Internal Revenue Code (IRC) section 265 which provides that no deduction is allowed for expenses allocable to one or more classes of tax-exempt income. The purpose of this provision is to prevent a double tax benefit.

Under section 1106(b) of the CARES Act, a recipient of a covered loan can receive forgiveness of indebtedness on the loan in an amount equal to the sum of payments made for the following expenses (“Qualifying Costs”) during the 8-week covered period beginning on the loan’s origination date:

  • Payroll costs
  • Any payment of interest on any covered mortgage obligation
  • Any payment on any covered rent obligation
  • Any covered utility payment

Typically, a borrower recognizes taxable income to the extent principal and interest are forgiven by a lender. However, Section 1106(i) of the CARES Act provides that any amount forgiven under section 1106(b) is excluded from a borrower’s taxable income. In Notice 2020-32, the IRS held that this exclusion results in a “class of exempt income” as defined under the IRC section 265 regulations. Accordingly, no deduction is allowed for Qualifying Costs since the amounts are allocable to tax-exempt income.

Is this the end?

In response to the IRS guidance, several Congressional leaders—including the chairmen of the Senate Finance Committee and House Ways and Means Committee—have voiced disagreement with the IRS notice and suggested enactment of additional legislation confirming the deductibility of Qualifying Costs. We will continue to monitor the tax deductibility of Qualifying Costs and make sure to update this insight to the extent future legislation or guidance is issued.