PPP Update: Expenses Paid For With Forgiven PPP Loans Are Not Deductible

Use of PPP Loan Proceeds to Pay Deductible Business Expenses The primary purpose of the Paycheck Protection Program is to help businesses retain employees at their current base pay, providing a desperately needed lifeline to businesses and their employees that were devastated by the COVID-19 pandemic.  

The maximum amount any small business or practice may borrow through the program is 250 percent of its average monthly payroll expenses incurred during the one-year period before the date on which the loan is made, up to a total of $10 million. Companies that actually received PPP funds could use those proceeds to pay expenses required to keep them afloat, including the costs of keeping employees on their payroll. 

Under section 1106(b) of the CARES Act that established the PPP, a recipient of a covered loan can obtain forgiveness of its indebtedness in an amount equal to the sum of payments made for the following expenses during the 8-week “covered period” that begins on the loan’s origination date:

• payroll costs;
• any payment of interest on any covered mortgage obligation;
• any payment on any covered rent obligation; and 
• any covered utility payment.

Generally, all of those foregoing expenses qualify for a deduction under Section 162 of the Internal Revenue Code as “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Additionally, Section 163(a) of the Code provides a deduction for certain interest paid or accrued during the taxable year on indebtedness, including interest paid or incurred on a mortgage obligation of a trade or business.

However, nothing in the CARES Act addresses the issue of whether deductions otherwise allowable under the Code are permitted if the loan is subsequently forgiven as a result of the payment of those costs.

Hence, the new IRS guidance on the matter. Specifically, the IRS noted that the Code and applicable regulations provide that a taxpayer cannot take a deduction for any amount otherwise allowable as a deduction if the expense is paid by any amounts allocable to a “class of exempt income.” It then concluded that forgiven PPP loan proceeds constitute just such a class of exempt income. Accordingly:

As a result of this ruling, small businesses that accept and use PPP loan proceeds face an increase in their taxable income and thus an increase in their tax burden that is directly at odds with the aid PPP loans was designed to provide. In response to the IRS guidance, legislators introduced the Small Business Expense Protection Act. This legislation would nullify the IRS guidance and provide that forgiveness of coronavirus assistance through the PPP would not affect the borrower’s ability to deduct their ordinary business expenses.

We will continue monitoring this and all other developments relating to COVID-19 and its impact on small business owners. If you have any questions related to the IRS guidance or PPP loans generally, please contact the business attorneys at Grogan Hesse & Uditsky.