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The IRS has Spoken: No Deduction for Expenses that Give Rise to Loan Forgiveness

One (of the many) questions that remained after the rollout of the Paycheck Protection Program (PPP) loans under the CARES Act was whether or not the expenses that the loan proceeds were used to pay would be deductible for tax purposes.  In IRS Notice 2020-32, which was released on April 30th, the IRS makes it very clear that any expenses incurred that give rise to loan forgiveness under Section 1106 of the CARES Act will not be deductible for federal income tax purposes.

So what does this mean?

In short, the forgiveness of the loan is not taxable, but the payroll, rent, interest, and utility costs that the loan was used to pay are not deductible.  This essentially puts taxpayers back in a similar federal tax position as if they had not received the loan (or loan forgiveness), and had not incurred the expenses that the loan proceeds were used to pay.

Background

Section 1106(i) of the CARES Act makes it clear that the forgiveness of a covered loan will not be considered taxable income.  This made everyone wonder if the expenses that the loan proceeds were used to pay would be deductible for tax purposes.  IRC Section 265 generally disallows a deduction for otherwise allowable expenses that are used to generate income that is exempt from tax.  The question remained though, how generous was the IRS willing to be during this pandemic?  Apparently, there is a limit to their generosity.

Note that this only applies in cases where taxpayers apply for, and receive forgiveness of a covered PPP loan.  Further, it only disallows a deduction for expenses to the extent that a taxpayer receives forgiveness.  For instance, if your PPP loan was $500,000, but only $450,000 of the loan was forgiven —for whatever reason — a deduction of $50,000 would still be allowed (assuming you incurred $500,000 of expenses).  Even if the total loan is forgiven, taxpayers would also be eligible for a tax deduction for any otherwise deductible expenses that exceeded the total amount of the loan.

Please be sure to check our COVID-19 Resource Center daily as we are regularly updating all of our guidance as changes happen. And if you have any questions or need more information, please do not hesitate to contact Mark Heath, Partner and Director of Tax Services at McKonly & Asbury at mheath@macpas.com.

Questions on submitting your PPP loan application or the forgiveness process?

Our team stands ready to assist you through the PPP loan application and forgiveness process. Do not go at it alone. Ensure you are submitting the right information and receiving the highest forgiveness amount possible. Visit our PPP Loan Consulting webpage by clicking here to request assistance or support.


This communication is intended to provide general information on legislative COVID-19 relief measures as of the date of this communication and may reference information from reputable sources. Although McKonly & Asbury has made every reasonable effort to ensure that the information provided is accurate, we make no warranties, expressed or implied, on the information provided. As legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that may modify some of the provisions in this communication. Some of those modifications may be significant. As such, be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed.


About the Author

Mark Heath

Mark is a Partner with McKonly & Asbury. Serving as Director of Tax Services, he brings a wealth of experience in federal, state, and international income as well as franchise tax issues for both publicly and privately held corporatio… Read more

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