A primary aspect of the CARES Act was the Paycheck Protection Program. It is so popular that additional funds were appropriated for it. The essence of PPP is that a business borrows from the SBA based on 2.5 months of last year’s payroll. If it spends the money within eight weeks on payroll and certain other expenses such as rent, the loan is forgiven. Please see our earlier newsletters or visit our website HERE for further background on the PPP Loan or assistance in navigating this process.
Normally when a loan is forgiven, it results in income to the taxpayer. The CARES Act indicates that is explicitly not the case with the forgiveness of a PPP loan. This gave PPP an extra attraction compared to letting employees collect unemployment, possibly supplementing that with relief payments deductible under Section 139 that would not be taxable to the employees.
However, it was identified by some that code Section 265 denies a deduction for otherwise allowable expenses that are allocable to exempt income. The IRS was aware of this and finally provided a ruling in Notice 2020-32 which states:
“Specifically, this notice clarifies that no deduction is allowed under the Internal Revenue Code (Code) 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 Coronavirus Aid, Relief, and Economic Security Act (CARES Act)”
This reduces some of the incentive to use PPP over unemployment if you really have nothing for people to do. There is the matter of what your future unemployment rate might be, but modelling that is very challenging.
Most likely, this ruling will be challenged in court unless Congress provides clarification. Until that time, the PPP can still be an effective tool to provide some much needed cash-flow even though the full tax impacts may not be hashed out yet.
Visit our COVID-19 Resource Page for more information regarding the PPP Loan forgiveness.