By Timothy J. Eifler
LOUISVILLE, Ky.—Despite initially threatening a veto, President Trump on Dec. 27, 2020, ultimately signed into law the Consolidated Appropriations Act, 2021, a combined COVID-19 relief measure/government spending plan. Included within this massive piece of legislation is the “COVID-related Tax Relief Act of 2020” (the “Relief Act”) which, among other things, overrules prior IRS guidance and confirms expenses paid with PPP loan proceeds are deductible even if the loan later is forgiven.
Business expenses generally are deductible. Expenses paid for or reimbursed by others are not. Section 265(a) of the Internal Revenue Code similarly effectuates these general principles by prohibiting taxpayers from deducting expenses funded with tax-exempt income.
These features of the U.S. income tax are founded on the general policy that allowing untaxed income to generate deductible expenses would provide an impermissible double tax benefit.
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) established the Paycheck Protection Program (“PPP”) as a new loan program administered by the U.S. Small Business Administration. The PPP was designed to assist small businesses adversely impacted by the COVID-19 emergency to pay certain business expenses. PPP loans are forgivable to the extent the recipients establish the funds are used to pay payroll, rent, utilities, and other qualifying expenses during a specified period of time after the proceeds are received.
The forgivable nature of the PPP payments normally would raise questions about the taxability of those funds—the discharge of debt generally results in an inclusion of the forgiven amount in a taxpayer’s gross income. The CARES Act overrides that general tax rule. The CARES Act provides that forgiven PPP loans are excluded from gross income. (See section 1106(i) of the CARES Act).
Soon after the PPP was enacted, taxpayers raised questions about the deductibility of expenses funded with PPP loans if the loans were forgiven. IRS quickly issued Notice 2020-32 in response. According to that notice, expenses funded with forgiven PPP loans are not deductible because they otherwise would provide a double tax benefit.
That notice left open the issue of whether expenses are deductible in the 2020 tax year when the loan would not be forgiven until 2021. IRS in Revenue Ruling 2020-27 later determined that if a taxpayer “reasonably expects” the loan to be forgiven, the taxpayer cannot deduct the expenses regardless of when the loan actually is forgiven.
The Relief Act nullifies the IRS’s taxpayer-unfriendly guidance by clarifying that expenses remain deductible even if funded by a forgiven PPP loan. Section 276 of the Relief Act states that “[f]or purposes of the Internal Revenue Code of 1986 … no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income provided by [the loan forgiveness provision that states forgiven PPP loans are not income].”
Owners of partnerships and S corporations get basis in their units/shares for their share of the excluded income. Section 276 addresses special allocations of partnership items by requiring the allocation of the exempt income to follow the allocation of the associated deductible expenses. This provision is effective for all taxable years ending after the date of the enactment of the CARES Act.
Timothy J. Eifler is a tax specialist member of Stoll Keenon Ogden PLLC.