In March 2020, the CARES Act was signed into law, and provided for forgiveness of Paycheck Protection Program (PPP) loans used to cover payroll and other enumerated expenses, and specifically stated that a forgiven PPP loan was not taxable income. The legislation did not speak to the treatment of business deductions paid with such loans. One month later – after millions of dollars of PPP loans had been distributed – the IRS published Notice 2020-32, which provided guidance on the agency’s position that otherwise deductible business expenses paid with forgiven PPP loans would not be deductible because under section 265 of the Internal Revenue Code they flowed from a class of tax-exempt income – a forgiven PPP loan. Treasury Secretary Steven Mnuchin publicly stated that such “double-dipping” was not allowed. Although Congress informed Treasury directly that its position was contrary to the congressional intent of the PPP and the tax community and small business stakeholders also voiced their concerns with the agency’s position, the IRS released additional guidance in November that reaffirmed its position that otherwise deductible business expenses paid with a forgiven PPP loan, or one with a reasonable expectation of forgiveness, were not deductible.
On December 4, 2020, the Office of Advocacy (Advocacy) held a roundtable to discuss the federal and state tax issues surrounding the PPP, which approximately 150 people attended. The roundtable speakers, representatives of KPMG and the Tax Foundation, both opined – and the majority of small business stakeholders in attendance agreed – that the IRS guidance on the deductibility of expenses paid with forgiven PPP loans missed the mark and undercut the purpose of the PPP. Advocacy conveyed the need for a legislative fix for the issue to the House and Senate Small Business Committees in a December 15, 2020, letter.
Without a legislative fix, small businesses with forgiven PPP loans or those with a reasonable expectation of forgiveness were facing likely tax increases of up to 37 percent for 2020. Congress stepped in and clearly stated that business expenses paid with forgiven PPP loans are deductible. Section 276 of the bill states:
For purposes of the Internal Revenue Code of 1986—
‘‘(1) no amount shall be included in the gross income of the eligible recipient by reason of forgiveness of indebtedness described in subsection (b),
‘‘(2) 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 paragraph (1), and
‘‘(3) in the case of an eligible recipient that is a partnership or S corporation-
‘‘(A) any amount excluded from income by reason of paragraph (1) shall be treated as tax exempt income for purposes of sections 705 of the Internal Revenue Code of 1986, and ‘‘(B) except as provided by the Secretary of the Treasury (or the Secretary’s delegate), any increase in the adjusted basis of a partner’s interest in a partnership under section 705 of the Internal Revenue Code of 1986 with respect to any amount described in subparagraph (A) shall equal the partner’s distributive share of deductions resulting from costs giving rise to forgiveness described in subsection (b).’’
The deductibility of business expenses paid with forgiven PPP loans is effective for subsequent PPP loans, as well as for business expenses paid with emergency Economic Injury Disaster Loan (EIDL) grants and targeted EIDL advances.