Another day; another new development in the Paycheck Protection Loan Program. This time from the IRS. As you probably know the CARES Act included a provision that specifically causes loan forgiveness to be excluded from income. It did this without amending the Internal Revenue Code. Tax professionals have been speculating as to whether the IRS would apply an existing Code Section (that treats expenses allocable to tax-exempt income as non-deductible) to the loan forgiveness income under CARES.
Late yesterday, the IRS released Notice 2020-32 and, indeed, IRS is applying existing tax law to treat the loan forgiveness as tax-exempt income and the expenses that result in the forgiveness as non-deductible. It specifically concludes that “… the direct link between (1) the amount of tax exempt covered loan forgiveness that a recipient receives pursuant to section 1106 of the CARES Act, and (2) an equivalent amount of the otherwise deductible payments made by a recipient for eligible section 1106 expenses, constitutes a sufficient connection for section 265(a) to apply to disallow deductions for such payments under any provision of the Code …”. Therefore, IRS will deny deductions for payments that create loan forgiveness to the extent of the forgiveness excluded from income.
What does not appear to be specifically included in this IRS logic is what the SBA has termed “owner replacement income”. For self-employed individuals, the SBA indicated that 8/52 of their self-employment income (up to $100,000) would be forgiven. So, that part of the loan forgiven (up to $15,385 per self-employed person), does not require the payment of expenses and, does not seem to come within the provisions of Notice 2020-32. At least for now.
For additional information, please see the RSM article: “Forgiven PPP loans result in disallowed deductions.”
Please reach out to your Pugh CPAs tax advisor for additional guidance. Again, our offices are currently closed but we are ALL available by phone and email.
Be well and stay safe!