Introduction
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) authorized approximately $350 billion to fund the Paycheck Protection Program (“PPP”). The PPP was designed to provide a direct incentive for small businesses to keep their workers on the payroll via potentially forgivable loans (“PPP Loans”), assuming certain criteria were met. The Consolidated Appropriations Act (“CAA”), signed into law by President Trump on December 27, 2020, has ended the debate on whether expenses paid with PPP Loan funds are deductible.
Background
Josh Sage previously published an article outlining the details of the CARES Act that addressed the PPP and requirements to qualify for a PPP Loan.[1] The short and sweet is that PPP Loans were designed to keep businesses open during the Covid-19 pandemic, and as long as the proceeds were used to pay specified expenses such as payroll and certain employee benefits relating to healthcare (with a portion available for rent, utilities, and interest on mortgage obligations) the loans would be forgiven but would not be considered cancellation of indebtedness income.[2] Generally when a taxpayer pays these type of expenses they are eligible to claim a corresponding deduction under section 161 and 162.
One key question left unanswered by the CARES Act however, was whether businesses would be able to deduct the expenses paid for with the PPP Loan funds if the loans were forgiven. Many practitioners felt that legislative intent was for taxpayers to still be able to deduct the expenses. Others felt that section 265, which generally disallows a deduction to the extent it is allocable to one or more classes of tax-exempt income, would disallow the deductions.
On April 30, 2020, the IRS issued Notice 2020-32, which held that taxpayers may not deduct the expenses paid with the PPP Loan funds if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the PPL Loan. The IRS laid out its explanation based on section 265 and other case law, stating that section 265 would disallow the deductibility of the expenses because such expense would be allocable to tax-exempt income in the form of loan forgiveness. The IRS further stated that the CARES Act contained no provision that allowed for deductions for expenses paid with PPP Loan funds and that the Treasury did not have the authority to grant the deductions, which was a matter of legislative grace.
Treasury Secretary Steven Mnuchin defending the guidance stated that “The money coming in the PPP is not taxable. So if the money that’s coming is not taxable, you can’t double dip,” Mnuchin said. “You can’t say you’re going to get deductions for workers that you didn’t pay for.”[3]
In preparation of publishing the next round of Coronavirus Aid legislation, Senate Finance Committee Chair Chuck Grassley stated in a December 18 Q&A that “Congress enacted the PPP to give a financial lifeline to small businesses, not deliver a financial tax liability.”[4] The American Institute of CPAs also issued a statement on the same day, supporting making PPP expenses deductible and cautioned Congress not to adopt a compromise proposal that would only allow deductibility for loans below a certain threshold.[5] The statement argued that “PPP recipients – particularly small businesses – cannot afford to be surprised with a tax bill next year on their PPP loan expenses and more than ever before need to be able to project how much cash they will have to cover their basic expenses. And for owners of small, pass-through businesses, this translates to their homes and families directly. Members of Congress must act now and pass this legislation to ensure that struggling businesses and their owners can recover.”
Confirmed Deductibility
With the signing of the CAA, we have a clear win for business owners. Section 276(a)(1)(i)(2) of the CAA states that “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income [related to the PPP Loan forgiveness].” Additionally, this also provides owners of passthrough entities with a step-up in basis from forgiven PPP Loans.
Mississippi should follow the new federal treatment due to House Bill 1748, enacted in June of 2020. The Bill disallows “a deduction for otherwise deductible payments paid with funds received under the PPP established by the CARES Act, but only to the extent those payments are not allowed as deductions for federal income tax purposes. To the extent such payments are allowed as deductions for federal income tax purposes, those expenses shall be deemed to have been incurred in connection with earning and distributing taxable income, notwithstanding that such payments resulted in forgiveness of loans received.”
The CAA clearly overrules Notice 2020-32, fully allowing a deduction for expenses paid for with PPL Loan proceeds, thus allowing business owners to have the government pay for their cake and eat it too.
[1] https://esapllc.com/cares-act/
[2] Normally when a taxpayer’s debt is forgiven or discharged for less than the full amount owed, the debt is considered cancellation of indebtedness income under section 108. This results in the taxpayer recognizing ordinary income on the amount of debt discharged. Depending on how the PPP Loan proceeds are used, the CARES Act excludes all or part of the amount forgiven from section 108.
[3] https://thehill.com/policy/finance/495996-mnuchin-defends-irs-guidance-on-ppp-loans
[4] https://www.grassley.senate.gov/news/news-releases/qa-fix-ppp-tax-glitch
[5]https://www.aicpa.org/press/pressreleases/2020/aicpa-and-its-members-urge-congress-to-support-ppp-expense-deductibility.html
