May 1, 2020
The IRS issued Notice 2020-32 on April 30, 2020. We are assuming for purposes of this update that you are familiar with the basics of the Paycheck Protection Program (PPP) and the fact that related loans may be forgiven if the loan proceeds are used for qualifying purposes during the required 8-week timeframe after funding.
Section 1106(i) of the CARES Act made it clear that the amount of any PPP loan forgiven under the CARES Act was excluded from gross income for all federal income tax purposes. However, the CARES Act was completely silent with respect to whether any limitation would be applied to the deductions that were being funded by the PPP loan (if it were forgiven.)
The IRS has made it clear in this notice that its position is that under the authority of section 265 and related regulations, all deductions which result in the forgiveness of any PPP loan will be disallowed. The IRS specifically states in the notice:
“…. 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 …. CARES Act … and the income associated with the forgiveness is excluded from gross income for purposes of the Code pursuant to section 1106(i) of the CARES Act.” The primary authority the IRS cites for the disallowance is section 265(a)(1) of the Internal Revenue Code.
Absent an official reversal by the IRS—some in Congress are questioning the notice, but any override legislation from Congress would not happen quickly—you should proceed as if this will be the final IRS position. Senator Grassley (R-Iowa), Chair of the Senate Finance Committee, reportedly made the statement, “This notice is contrary to that intent,” in referring the intent of Congress in the CARES Act.
PPP borrowers will now have to evaluate this loss of deductions along with several other factors.
As a reminder, the most recent Treasury and SBA guidance (see Treasury PPP Q&A #31 and 37) retroactively imposed a requirement that all borrowers evaluate their liquidity in determining whether their PPP loan certification was valid. If not, the borrower can only avoid sanction from the Treasury/SBA by repaying the PPP loan on or before May 7, 2020. The Treasury language states: “Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.” Treasury has also made specific statements that it intends to audit every PPP loan in excess of $2 million (this does not preclude them from auditing smaller loans), and that it expects criminal sanctions to possibly apply for certifications it determines to be invalid.
After a company receives a decision from their lender that there is PPP loan forgiveness, they are not eligible to defer payment of the employer share of 2020 social security taxes on payroll tax due after that date. The previously deferred payroll tax continues to be eligible for deferral to 2021 and 2022.
Each borrower must add to their analysis the effect of the loss of tax deductions (equal to any PPP loan forgiveness projected), on top of any risk they perceive with respect to their certification with the liquidity analysis required. This will help decide whether they should continue to pursue a loan or its forgiveness and whether the safe harbor repayment required by May 7, 2020, should be considered.
Disclaimer: The information contained in this communication, including attachments and enclosures, is not intended to be a complete analysis of all related issues. Nor is it sufficient to avoid tax-related penalties. It has been prepared for informational purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and Perkins & Company, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.