by Joel Shabsin, CPA
On May 1, 2020 the IRS issued Notice 2020-32 to clarify the treatment of the PPP program’s loan forgiveness. The notice discusses the allowed uses of funds in order to qualify for forgiveness and goes on to further explain that the expenses paid using the PPP loan amounts are not deductible as ordinary and necessary expenses in determining taxable income. The
notice, which is available on the IRS website explains the tax laws and court cases that led the IRS to this conclusion. The purpose of this conclusion was, according to the IRS, to avoid allowing taxpayers to “double dip”, by excluding the loan forgiveness from income while deducting the expenses the funds were used for. For example assume that a small business received a $50,000 PPP loan. At the end of the year it had gross revenue including the cancellation of debt income of $450,000, and expenses of $350,000, including the payroll, rent, utilities and interest used to justify loan forgiveness of $50,000. Before the exclusion of the loan forgiveness the tax return for the full year would show the following:
Gross sales $400,000
Cancellation of debt income 50,000
Total income 450,000
Other Expenses 75,000
Total expenses 350,000
Taxable income $100,000
Taking a $50,000 write off for forgiveness of debt would reduce the taxable income from $100,000 to $50,000. In effect this, if allowed, would give the business a $50,000 tax break by taking the deduction but also allowing it to deducting the expenses the PPP loan was used for. Therefore the $50,000 of expenses paid with the tax free money are not allowed as deductions against income so taxable income remains at the $100,000 level, the same it was at before the forgiveness of debt. The AICPA, on the other hand strongly disagrees with the IRS’s stance of denying deductions for expenses paid with forgiven PPP loans. The reasoning they are putting forth is that Congress’ intent in the CARES Act was to allow businesses to continue to deduct all of their ordinary and necessary expenses used in determining the loan forgiveness. They cite the taxability provision of the Act that makes the PPP loan forgiveness non taxable and the fact that under the IRS’ interpretation tax forgiveness in the Act has no meaning. As a result of these 2 different interpretations the AICPA is planning to ask Congress for legislative clarification and hope to receive a response sometime next week.
If you are interested in the IRS’ reasoning and tax law citations justifying their reasoning, check out Notice 2020-32. But more importantly keep in mind that unless the IRS changes their position, a client showing non taxable cancellation of debt income as a result of the PPP loan forgiveness must also show the expenses that the tax free loan forgiveness were applied against as non deductible expenses thereby negating the tax free provision of the CARES Act. For Corporations, partnerships and S Corporations, these would be shown as schedule M-1 adjustments and for Schedule C filers, as other income and other expense items as appropriate.
Caution: This information is for tax professionals only. It is not intended as specific advice for taxpayers