IRS: PPP Loan forgiveness triggers loss of tax deductions

The IRS today announced (Notice 2020-32) that forgiveness of Paycheck Protection Plan loans will result in the loss of some tax deductions:

To the extent that section 1106(i) of the CARES Act operates to exclude from gross income the amount of a covered loan forgiven under section 1106(b) of the CARES Act, the application of section 1106(i) results in a “class of exempt income” under §1.265-1(b)(1) of the Regulations. 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.

The IRS bases this on long-standing tax law that disallows expenses that generate tax exempt income.

Expenses taken into account in determining loan forgiveness under the program include payroll, payments under mortgage obligation, rent, utility payments, and certain other interest. How forgiveness is determined is still unclear; for example, it's not certain whether falling short of maintaining 75% of payroll reduces forgiveness or eliminates it entirely. That will matter in determining the deduction disallowances.

This will be one more factor for businesses to consider in choosing between PPP loan forgiveness and employee retention tax credits. Watch our COVID-19 coverage for further developments.

Related: How to Maximize Your Loan Forgiveness Under the Paycheck Protection Program