December 11, 2020

PPP Loan Forgiveness is Not Allowed to Result in Double-Dipping

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• Congress failed to expressly address the effect of PPP Loan forgiveness on the deductibility of CARES Act §1106 payments.

• IRS will apply IRC §265(a)(1) such that taxpayers are prohibited from deducting otherwise deductible payments if forgiven PPP Loan proceeds were used to make those payments.

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We have continued to update our readers on the significant developments pertaining to the Paycheck Protection Program (PPP).¹ Here we discuss a notice just released by the Internal Revenue Service (IRS) on April 30, 2020,² wherein the IRS has determined that taxpayers are prohibited from deducting otherwise deductible payments if forgiven PPP Loan proceeds were used to make those payments.

Obviously, this development is a disappointment to many recipients and, perhaps Congress as well, considering the recent Bloomberg report indicating that Senate Finance Committee Chairman Chuck Grassley (R-Iowa) was disappointed with the IRS guidance, quoting Grassley as saying:

The intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible,” […] “This notice is contrary to that intent.³“

Similarly,⁴ Chris Hesse, CPA, chair of the AICPA Tax Executive Committee, is quoted in the Journal of Accountancy as saying:

In effect, the IRS guidance means that the taxability provision [Section 1106(i)] has no meaning. Why waste the ink to say that for purposes of the Code, the loan forgiveness is not includible in income, if the government will just take away deductions in the same amount?⁵“

IRC §265(a)(1): No Double-Dipping

The IRS has long maintained that if taxpayers are permitted to deduct expenses paid with tax-exempt income, they would in effect realize a double tax benefit.

Per Internal Revenue Code (IRC) §265(a)(1) no deduction is allowed for:

[a]ny amount otherwise allowable as a deduction which is allocable to one or more classes of income [. . .] wholly exempt from the taxes imposed by this subtitle.”

In other words, the IRS disallows an otherwise allowable deduction under IRC, including §§162 (trade or business expenses) and 163 (interest), if such expenses are already wholly tax exempt.

For instance, in Rev. Rul. 83-3 the IRS ruled that the recipient of a nontaxable Veterans’ Administration (VA) educational allowance was not also able to deduct IRC §162 educational expenses (otherwise deductible under §162) to the extent that the expenses were allocable to the VA benefits.⁶

Notice 2020-32

Again, the recent notice clarifies 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] and the income associated with the forgiveness is excluded from gross income . . . pursuant to section 1106(i) of the CARES Act.”

In reaching this determination, the IRS declared that no provision of the CARES Act specifically addresses the effect of PPP Loan forgiveness on the deductibility of CARES Act §1106 payments.

In the notice the IRS asserted that its position is consistent with earlier IRS guidance, including Rev. Rul. 83-3 discussed above. Additionally, the IRS considered case law and similarly concluded that PPP Loan forgiveness is not going to be allowed to result in double-dipping.

Conclusion

Struggling businesses need all the help they can get now—and this interpretation means they will be prohibited from taking deductions to help lower their income tax burden. Since Congress didn’t expressly address this issue in the CARES Act, the IRS’s conservative interpretation will likely stand unless the lawmakers step in and correct it.

If you have questions or concerns about PPP Loan forgiveness, call Frost Law at 410-862-2806 or contact us online.

Footnotes

  1. https://askfrost.com/cares-paycheck-protection-program-loans-to-help-small-businesses/
  2. Notice 2020-32, 2020-21 I.R.B. __ (May 18, 2020).
  3. Lydia O’Neal, Loan Forgiveness Deductions Left in Hands of Congress, Daily Tax Report (May 1, 2020), https://www.bloomberglaw.com/product/tax/document/X9R23G0S000000.
  4. CARES Act, §1106(b) and (i).
  5. Sally P. Schrieber (May 1, 2020), AICPA challenging nondeductibility of PPP-related expenses, available at:https://www.journalofaccountancy.com/news/2020/may/expenses-reimbursed-by-ppp-not-tax-deductible-paycheck-protection-program.html.
  6. 1983-1 C.B. 72.
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