PPP Update: Expenses Paid For With Forgiven PPP Loans Are Not Deductible
Jordan Uditsky • May 15, 2020
In its recently issued guidance, the Internal Revenue Service (IRS) clarified that business owners who pay otherwise deductible business expenses with Paycheck Protection Program (PPP) loan proceeds cannot deduct those expenses for tax purposes if the loan is ultimately forgiven.
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.
Forgiven Loan + Deductions for Business Expenses = Prohibited Double-Dipping
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:
“Section 265(a)(1) of the Code disallows any otherwise allowable deduction under any provision of the Code, including sections 162 and 163, for the amount of any payment of an eligible section 1106 expense to the extent of the resulting covered loan forgiveness (up to the aggregate amount forgiven) because such payment is allocable to tax-exempt income. Consistent with the purpose of section 265, this treatment prevents a double tax benefit.”
Legislators Seek to Nullify IRS Guidance
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.
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That's because these "testers" and the lawyers who represent them specifically target small businesses, as they typically have limited means to defend themselves, may not be able to discern between legitimate and bogus claims, and often see a quick payoff as the path of least resistance. Here’s how the shakedown typically goes down: A plaintiff or their attorney sends the practice a demand letter in which they claim that the practice’s website is inaccessible to people with disabilities (e.g., missing image alt text, inaccessible forms, incompatible with screen readers). They cite a violation of Title III of the ADA. They make a demand for a cash settlement, often ranging from $2,500 to $25,000, alongside a request for accessibility fixes. The business/practice cuts a check in exchange for a release of any ADA claims by that plaintiff related to the website. 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We bring unique insights and deep commitment to protecting the interests of dental professionals and their practices and welcome the opportunity to work with you. Jordan Uditsky, an accomplished businessman and seasoned attorney, combines his experience as a legal counselor and successful entrepreneur to advise dentists and other business owners in the Chicago area. Jordan grew up in a dental family, with his father, grandfather, and sister each owning their own dental practices. This blend of legal, business, and personal experience provides Jordan with unique insight into his clients’ needs, concerns, and goals.
