Expenses Paid With Forgiven PPP Loans Not Tax Deductible

COVID-19 Update

The Paycheck Protection Program established by the CARES Act provides for loans to small businesses affected by COVID-19 to cover payroll and other costs for a period of eight weeks. The recipient of a covered loan may use the proceeds to pay (1) payroll costs, (2) certain employee benefits relating to healthcare, (3) interest on mortgage obligations, (4) rent, (5) utilities and (6) interest on any other existing debt obligations.

Subject to various limitations described in Congressional Action—Lending Programs and Relief Provisions Under the CARES Act, the recipient of a covered loan may receive forgiveness of the loan in an amount equal to the sum of payments made for the following expenses during the eight-week “covered period” beginning on the covered loan’s origination date: (1) payroll costs, (2) any payment of interest on any covered mortgage obligation, (3) any payment on any covered rent obligation and (4) any covered utility payment. For federal income tax purposes, the loan forgiveness amount is not included in the gross income of the loan recipient.

In Notice 2020-32, the IRS has advised that, because the forgiven amount of a covered loan is excluded from gross income, Section 265(a)(1) of the Internal Revenue Code disallows any federal income tax deduction for the payment of eligible expenses to the extent of the resulting covered loan forgiveness (up to the aggregate amount forgiven) because such payment is allocable to tax-exempt income. The IRS has determined this to be consistent with the purpose of Section 265, by preventing the double tax benefit that would result if both loan forgiveness were excluded from income and expenses paid with the forgiven loan were tax deductible.

How Manatt Can Help: Manatt’s tax practice is keeping abreast of the various tax aspects of the loans received under the Payroll Protection Program under the CARES Act. We are here to help clients navigate these new and changing requirements and take full advantage of the loan forgiveness relief being made available.

For More Information: Contact David Herbst, partner, Manatt Tax, at dherbst@manatt.com or 650.812.1320, or Jeffrey A. Mannisto, partner and leader, Manatt Tax, at jmannisto@manatt.com or 310.312.4212.

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