IRS Guidance Says No Deduction Is Allowed for Business Expenses Paid with Forgiven PPP Loans (IN11378, Version 8, Updated October 7, 2020)

Summary

Version 8 of CRS Insight IN11378 (October 7, 2020) is a condensed rewrite. It drops the loan cap and funding authorization details of the earlier versions and shortens the forgiveness discussion to say borrowers can apply for forgiveness if they maintain employment and limit wage decreases. It keeps the explanation that forgiven debt is generally taxable cancellation of indebtedness income unless excluded, that Section 1002 of the CARES Act excludes forgiven loan amounts, and that IRS Notice 2020-32 of April 30, 2020 bars deductions for the expenses under Section 265(a)(1). It also keeps the section on tax practitioners' concerns.

Summary drafted by a model from the document's text below and checked by script against that text before publication. It is a navigation aid, not a reading of what the document proves. Where AI is used

Full text

                                                                                               INSIGHTi



IRS Guidance Says No Deduction Is Allowed
for Business Expenses Paid with Forgiven PPP
Loans

Updated October 7, 2020
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act; P.L. 116-136) created Small
Business Administration (SBA) Paycheck Protection Program (PPP) loans that can be used to cover
payroll expenses and certain operating costs and can be forgiven if the borrower meets certain criteria.
On April 30, 2020, IRS issued Notice 2020-32, stating that PPP-recipients cannot claim a deduction for
expenses funded from the forgiven PPP loans.


PPP Forgiveness
Borrowers can apply for forgiveness on the principal and accrued interest, if the borrower maintains
employment and limits wage decreases.
In general, forgiven debt—“cancellation of indebtedness income” or CODI—is subject to income
taxation, unless specifically excluded. Section 1002 of the CARES Act, excludes forgiven loan amounts.


Tax Deductibility of Business Expenses
The CARES Act has no language on the deductibility of PPP expenses. Under Internal Revenue Code
(IRC) Sections 162 and 163, taxpayers can deduct any ordinary or necessary trade or business expenses,
which would include PPP-eligible expenses.
However, IRC Section 265(a)(1) states that an expense cannot be deducted if it is allocable to a class of
income which is exempt from taxation.

Tax Practitioners’ Concerns About Deductibility of Forgiven PPP Loans
In an April 8, 2020, email to the U.S. Department of the Treasury (link requires paid subscription),
Cornell Law School Professor Richard L. Reinhold argued that legislation could be needed if Congress

                                                                          Congressional Research Service
                                                                            https://crsreports.congress.gov
                                                                                                   IN11378

CRS INSIGHT
Prepared for Members and
Committees of Congress
Congressional Research Service                                                                                             2




intended to allow a deduction for covered expenses incurred by a taxpayer whose loans are forgiven. In
contrast, others argue (links requires paid subscription) that Section 265 should not apply.

Double Benefit
A “double benefit” arises when a taxpayer receives tax-free income (like a forgiven loan) and is also able
to claim a tax benefit (like a deduction or a credit) using that income. For example, assume a taxpayer
faces a top marginal income tax rate of 37% and takes out a PPP loan for $100,000 that is forgiven by the
lender and not subject to tax. The first benefit is a tax-free grant of $100,000. If the taxpayer can also
deduct the loan amount as business expenses, a second benefit is $37,000 in tax savings ($100,000 *
37%).
If Congress meant to disallow this “double benefit,” a question can be raised as to why the exclusion of
the loan forgiveness was explicitly provided in the legislation. To illustrate, Table 1 assumes a $100,000
forgiven loan, $100,000 of deductible expenses, and a 37% tax rate. The normal treatment in the tax code
(the forgiven loan is taxable, and the associated business expenses paid from that loan are deductible)
would generate a $37,000 tax liability from that taxation of the CODI (scenario 1). But that amount would
be entirely offset by a $37,000 tax savings from deducting the business expenses. Excluding the forgiven
loan results in no tax on the income, but allowing deductions provides a tax saving of $37,000 (scenario
2). If, however, the forgiven loan is not taxed and deductions are disallowed, there is no tax on the income
or benefit from the deduction. Including the loan in income and allowing deductions (scenario 1) leads to
the same outcome as excluding the loan and disallowing deductions (scenario 3). Hence, one could argue
that this exclusion was included in the law because it was Congress’s intent to provide this additional
benefit.

                            Table 1. Hypothetical Example of Tax Effect
                  of Disallowing Deductions for Business Expenses on PPP Loans
                                                                       Tax Savings from the
              Tax Scenario                     Tax On Income                Deduction                  Net Tax Effect

 1. Normal Tax Treatment                            $37,000                    -$37,000                       0
 2. Treatment w/ Exclusion on Forgiven
                                                       0                       -$37,000                    -$37,000
 Debt
 3. Treatment w/ Exclusion on Forgiven
                                                       0                           0                          0
 Debt and No Deduction

    Source: CRS calculations, assuming a $100,000 forgiven loan, $100,000 in deductible business expenses, and a 37% tax
    rate.


April 30, 2020, IRS Guidance
IRS Notice 2020-32 disallows deductions for expenses paid for by forgiven PPP loans. Tax filers may
need to amend quarterly filings or might challenge this decision in court, although it is not clear what the
outcome of that option would be. Some policymakers have expressed concerns with IRS’s guidance,
including the chairs of the House Ways and Means and Senate Finance Committees.

Treatment in Revenue Estimates
According to media reports, the Joint Committee on Taxation—in a July 27, 2020, letter to Senator John
Cornyn—indicated that the revenue estimate for the CARES Act was consistent with its interpretation of
Congressional Research Service                                                                                        3




 the intent of allowing deductibility of expenses, and that legislation affirming the deductibility of
expenses would have no revenue effect.


Economic Benefit of PPP Loans
IRS’s position would reduce the economic benefit of PPP loans to taxpayers who thought they could
continue to take deductions for PPP-eligible expenses. Businesses could lay off employees and not apply
for PPP loan forgiveness. With that said, businesses could still find that PPP loans are the most preferable
option for short-term economic relief compared to alternative COVID-19 assistance measures.


Options for Congress
If Congress decides that Section 265(a)(1) should be waived for business expenses funded by forgiven
PPP loans, it could enact subsequent legislation. Congress has enacted some exemptions, such as those in
IRC Section 265(a)(6) (mortgage interest and property taxes deductible on a home receiving a tax-free
military housing allowance or a parsonage allowance for religious clergy). The Safeguarding Small
Business Act (S. 3596), the Heroes Act (H.R. 6800), the Small Business Emergency Protection Act (H.R.
6821; S. 3612), and the Safeguarding Small Business Act (S. 3596) would amend the CARES Act to
allow taxpayers to receive PPP loan forgiveness without affecting their ability to claim expense
deductions. An updated version of the Heroes Act (H.R. 925), which allows deductibility, passed the
House on October 1.


Author Information

Sean Lowry                                                 Jane G. Gravelle
Analyst in Public Finance                                  Senior Specialist in Economic Policy




Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff
to congressional committees and Members of Congress. It operates solely at the behest of and under the direction of
Congress. Information in a CRS Report should not be relied upon for purposes other than public understanding of
information that has been provided by CRS to Members of Congress in connection with CRS’s institutional role.
CRS Reports, as a work of the United States Government, are not subject to copyright protection in the United
States. Any CRS Report may be reproduced and distributed in its entirety without permission from CRS. However,
as a CRS Report may include copyrighted images or material from a third party, you may need to obtain the
permission of the copyright holder if you wish to copy or otherwise use copyrighted material.




                                         IN11378 · VERSION 8 · UPDATED


File and source

File

IN11378.8.pdf

Size

678,084 bytes

SHA-256

dc4c1b8448db76eb11cd06825d33b732c8a054fc4a9f51f7d5f1b62992e1e037

Our copy

IN11378.8.pdf

Original

crsreports.congress.gov