Tax issues created by PPP loan forgiveness

The Coronavirus Aid, Relief, and Economic Security (CARES) Act expressly provides that Paycheck Protection Program (PPP) loan forgiveness is excluded from gross income. Generally, debt cancellation creates taxable income for the borrower unless specific exclusions available under the tax code apply (see loan modification article). In exchange for escaping current taxation under these exceptions, taxpayers are required to reduce their tax attributes (net operating losses, basis in depreciable assets, etc.). The CARES Act does not incorporate this concept. 

While the cancellation is excluded from gross income for federal purposes, the Treasury Department has ruled that expenses funded by subsequently forgiven PPP loan proceeds are nondeductible for federal tax purposes. Despite the fact that the CARES Act was silent on the matter, the IRS released Notice 2020-32, which provides that no deduction is allowed for an otherwise deductible expense if the payment of the expense results in the forgiveness of a covered loan under the CARES Act, and the income associated with the forgiveness is excluded from gross income. Immediately following the release of Notice 2020-32, many ranking members in Congress (on both sides of the aisle) rebuked the IRS’ position, stating the intent of the CARES Act was for the expenses to remain deductible. While several bills have been introduced to override the notice (most recently the House’s Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act updated in late September), none have yet to pass both chambers of Congress.

The notice provides little information beyond rendering the expenses nondeductible. Several questions have arisen as a result, specifically regarding the treatment of expenses related to loan forgiveness, when any forgiveness has not occurred by the taxpayer’s taxable year-end. Unfortunately, no guidance addressing this issue is available. There has been some conjecture advancing two possible approaches:

• First, treat each year as a stand-alone matter and, if the debt forgiveness has not occurred by the close of the taxable year, there would be no limitation on deductible expenses in that year. The argument being that if there is no forgiveness during 2020, then there is no class of tax-exempt income that would limit the corresponding expenses.
• The issue is of even more pressing concern to fiscal-year taxpayers, who may already have closed tax years on extensions and have had PPP loans forgiven or are in the process of having them forgiven.
• Second, the IRS may take a view that the expenses should still be limited in accordance with Notice 2020-32. Such a position could be based on the theories behind the tax benefit rule or the open transaction doctrine. The IRS could also view the forgiveness application as ministerial in nature and has to be accounted for as the loan proceeds are expended.

There is also the issue of whether taxpayers are bound by the notice since it does not appear to follow congressional intent. Some businesses are arguing the underlying rationale of the notice is questionable given Congress clearly intended a tax benefit when this provision was enacted.

As a result, some taxpayers may take a position contrary to Notice 2020-32 on their returns. For taxpayers considering such a position, they should discuss with their advisors the potential need for a formal disclosure of their position on the return.

We believe the best course of action is to continue to wait for either additional guidance from Treasury or the IRS, or for Congress to act. There have been some discussions that Congress may address this issue in a post-election session since making the PPP accommodating to borrowers (including overturning Notice 2020-32) has been an item of interest shared on both sides of the aisle. However, the willingness of members to cooperate and enact any legislation after Nov. 3 is likely dependent upon the outcome of the election and whether there is any degree of bipartisan interest in passing legislation during a lame-duck session.

It should also be noted that even though the cancellation is not included in gross income for federal purposes, the treatment at the state level could vary. States may require the cancellation be included in determining the borrower’s state taxable income depending on their respective rules.

For more information on this topic, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.