No Double Dipping: IRS Confirms Non-deductibility of Expenses Paid With Forgiven Paycheck Protection Program Loan Proceeds
In the past few weeks, we have seen the government simultaneously implement a number of different mechanisms to assist businesses and individuals in navigating the COVID-19 pandemic. In addition to the four COVID-related bills passed by Congress, we have seen a number of government departments and agencies issue their own regulations, Q&As, and other guidance in an effort to provide those affected by this pandemic with as much information as quickly as possible. Although the guidance provided by each legislative body or agency varies, we can identify certain commonalities in the policy behind each agency’s guidance, with possibly the most prevalent theme being a prohibition on stacking benefits available under differing programs (otherwise known as “double dipping”).
The most recent example of this advice is the IRS’s issuance of Notice 2020 – 32 on April 30, 2020, which clarifies that a taxpayer may not claim a deduction for an expense if that expense was paid using loan proceeds under the Paycheck Protection Program (“PPP”) that were ultimately forgiven. For more information of the PPP, please see our previous article regarding PPP eligibility. The IRS has based this determination on the fact that Section 265(a)(1) of the Internal Revenue Code (the “Code”), as well as Section 1.265−1 of the Treasury Regulations, prohibits taxpayers from taking a deduction for an amount that is allocable to “one or more classes of income other than interest…wholly exempt from taxes imposed by subtitle A of the Code.” For purposes of Section 265(a)(1), a “class of exempt income” is “any class of income…that is either wholly excluded from gross income under any provision of subtitle A of the Code or wholly exempt from the taxes imposed by subtitle A of the Code under the provisions of any other law.” See Treasury Regulation section 1.265 – 1(b)(1), as cited in Notice 2020 – 32.
In a nutshell, Section 265 prohibits taxpayers from whipsawing the IRS. Without this provision, a taxpayer receiving tax-exempt income could use that income to pay additional expenses and increase its expense deduction. By doing so, not only would that taxpayer receive the benefit of excluding part of its income from tax, but that taxpayer would also be able to use these tax-exempt funds to increase the amount of the deduction available to offset any income the taxpayer is required to include in calculating its tax due.
How does this apply to the CARES Act? As written, Section 1106(i) of the CARES Act states that any covered loan amounts forgiven under Section 1106(b) of the CARES Act will be excluded from gross income. Therefore, any amounts forgiven will be considered a “class of exempt income” under Treasury Regulation 1.265 – 1(b)(1), and any otherwise allowable expenses paid using the forgiven loan proceeds may not be deducted. A deduction should, however, be available for otherwise deductible expenses paid by a taxpayer using any loan proceeds that were not forgiven under the PPP.
If you have any questions regarding the PPP or this notice, please feel free to contact a member of our Tax Practice Group.
DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.