Expenses funded with PPP loans.

• Author: Parikh, Abhi
• Position: Paycheck protection program

The Paycheck Protection Program (PPP) is a federally guaranteed Small Business Administration loan program that was created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, PL. 116-136, which became law on March 27, 2020. As of this writing, lawmakers are considering the possibility of expanding the PPP program but have yet to do so. This item discusses tax issues related to the forgiveness of PPP loans.

Under the PPP, a recipient of a covered loan can use the proceeds to pay

* Payroll costs;

* Employer health care;

* Interest on mortgage obligations;

* Rent;

* Utilities; and

* Business interest.

The maximum PPP loan is based upon 21/2 months' average payroll costs for the prior 12 months. The entire debt may be forgiven if the business pays qualifying costs over the covered period beginning with the funding of the loan. The discharge of a PPP loan is excluded from the business's gross income for federal income tax purposes, but the corresponding expenses paid with the loan proceeds are deemed not deductible, as discussed in more detail below.

PPP loans and forgiveness

Borrowers of a PPP loan are not subject to tax on their receipt of proceeds because there is a requirement to repay the loan. This is the same as with any ordinary loan. With an ordinary loan, if all or part of the debt is forgiven, cancellation-of-debt (COD) income arises because the taxpayer has been released from the obligation to repay and this is viewed as an accession to wealth (Sec. 61(a)(ll)).This principle would have applied to loan forgiveness under a PPP loan, but Section 1106(i) of the CARES Act states that "any amount which... would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income."

Thus, borrowers who are released from their obligation to repay a PPP loan do not have COD income. Loan forgiveness may affect their taxes in other ways, however. Borrowers may have to pay additional income tax as a result of the loan forgiveness because expenses funded by the PPP loan are not deductible for tax purposes. Under Notice 2020-32, the IRS took this position, stating that "no deduction is allowed under the Internal Revenue 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...