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CLARIFICATION ON DEDUCTIBILITY OF PPP LOAN EXPENSES

CLARIFICATION ON DEDUCTIBILITY OF PPP LOAN EXPENSES

Many taxpayers have received, or will soon receive, their Paycheck Protection Program (PPP) loan. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) which created the PPP, states that the proceeds of the loan are to be used to cover qualifying expenses, mainly payroll, of the business. Because the PPP was meant to be an assistance and form of economic stimulus to small businesses and their employees, one feature of the PPP was that a portion or all of the loan proceeds could be forgiven. The one clear thing in the CARES Act was the taxability of the forgiven loan – it was not to be included in taxable income for federal income tax purposes.

The IRS, through the issuance of Notice 2020-32, has now clarified the treatment of the expenses paid related to the portion of the PPP loan forgiven – they will be non-deductible.

Under the Internal Revenue Code, expenses related to tax exempt income are non-deductible. The IRS has reasoned that the portion of the PPP loan forgiven is a class of tax-exempt income. Therefore, rendering the expenses paid related to the forgiven portion of the PPP loan as non-deductible.

Taxpayers may have to revise their budgets or cash flow projections if their original budgets or projections included the tax savings of what was thought to be fully deductible PPP expenses.

For instance, an individual with a partnership or S corporation, assuming a tax rate of 35% (federal, state and local) on the flow through income, with disallowed PPP expenses of $500,000 (due to $500,000 of debt forgiveness), would now need to include an additional $175,000 of taxes in their budget or cash flow projections.

With this news, we now know for a taxpayer that receives a PPP loan:

  • The forgiven portion of the PPP loan will not be included in taxable income
  • Expenses related to the portion of the PPP loan forgiven are non-deductible
  • A business that receives a PPP loan is not eligible for the Retention Credit on the wages paid, and
  • A business that has any portion of a PPP loan forgiven cannot defer the payment of payroll taxes (the Social Security matching portion) after receiving the notice of the loan forgiveness

We continue to await additional guidance on other aspects of the PPP, including the loan forgiveness calculations, and will provide updates once available.

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