By: Joy L. Hall & Michael L. Iannitti
Congress created the Paycheck Protection Program (PPP) as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The purpose of the PPP is to provide loans on favorable terms to small businesses to cover payroll and certain other costs. PPP loans are subject to forgiveness to the extent that a borrower uses PPP funds for payroll costs and certain mortgage interest, rent and utility obligations during the 8 week period following loan disbursement.
At least 75% of PPP loan proceeds must be used for payroll costs only. Additionally, the amount subject to forgiveness is reduced based on any reductions in employees or payroll during this 8 week period. The CARES Act also excludes any amount of loan forgiveness from gross income. Therefore, borrowers will not recognize cancellation of debt income for the amount forgiven.
The IRS has issued recent guidance that disallows a deduction for any expenses attributable to forgiven PPP loans. Payroll costs, rent, utilities and mortgage interest are generally deductible as typical trade or business expenses. However, the tax code prohibits a deduction for any expenses allocable to tax exempt income.
The IRS has concluded that any PPP loan proceeds that are forgiven qualify as a “class of exempt income,” and any allocable deductions are disallowed. The IRS has found a sufficient connection between the forgiven loan proceeds and the otherwise deductible PPP expenses to prohibit a deduction.
As a result of the IRS’ guidance, borrowers may not deduct payroll costs or other eligible expenses to the extent these expenses were paid with forgiven PPP loan proceeds. Any expenses paid for with PPP loan proceeds that are not forgiven may still be deducted in the ordinary course of business.