Calfee will be distributing a daily COVID-19 First Alert Compilation email, containing links to today's new First Alerts related to the novel coronavirus and its impact on organizations and individuals. "Breaking legal news" alerts may be distributed separately.
Breaking News COVID-19 First Alert Thursday, April 30
The “Payroll Protection Program” Congress created as part of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) has been quite popular for many reasons, but two in particular. First, if spent properly (on items such as payroll, rent and utilities), amounts received initially as loans can be forgiven under Section 1106(b) of the CARES Act. Second, under Section 1106(i) of the CARES Act, amounts that are forgiven are excluded from gross income, meaning the borrower receives the loan amount (without a repayment obligation) entirely tax-free.
This immediately led to a very
important question among tax practitioners: Whether loan amounts that are spent on normally tax-deductible items such as payroll and rent could still be deducted for tax purposes if the loan is ultimately forgiven. The question arises because Section 265 of the Internal Revenue Code provides that a taxpayer cannot take tax deductions, even if otherwise allowable, if the deductions are allocable to income that is exempt from tax. The general purpose of Section 265 is to prevent taxpayers from enjoying a “double” tax benefit (i.e., tax-exempt income generating tax deductions).
In Notice 2020-32, released today, the IRS clarifies that Section 265 does in fact apply to PPP loans and
prevents taxpayers from deducting expenses that lead to forgiveness under the CARES Act. This interpretation will have the effect of negating much (if not all) of the tax benefit Congress provided with the exclusion under Section 1106(i). Given the larger goal of Congress to inject cash into struggling businesses, this result had some wondering (before today) whether the IRS would apply Section 265 to PPP loan forgiveness.
Calfee will continue to monitor this situation, but short of an act of Congress, it appears that taxpayers receiving PPP loans are left with this more limited tax benefit.
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