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IRS says expenses funded by forgiven PPP loan amounts are non-deductible

May 01, 2020

On April 30, 2020, the IRS issued Notice 2020-32, holding that covered expenses paid from PPP loan amounts that are forgiven under Section 1106 of the CARES Act are not deductible for income-tax purposes.

The IRS recognized the expenses were ordinary and necessary expenses and that the amount of the loan forgiven under the CARES Act is not included in gross income, but it determined that IRC section 265, which disallows expenses related to tax-exempt income, applies. 

In the notice, the IRS provided the following comments:

“Section 265(a)(1) of the Code applies to otherwise deductible expenses incurred for the purpose of earning or otherwise producing tax-exempt income. It also applies where tax exempt income is earmarked for a specific purpose and deductions are incurred in carrying out that purpose. In such event, it is proper to conclude that some or all of the deductions are allocable to the tax-exempt income.”

“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.”

It is now up to Congress to determine if they want to legislatively overrule this notice and allow for deductions of covered expenses that are excluded from gross income under the CARES Act.

For more information on the various impacts of COVID-19 on individuals and businesses, visit our COVID-19 resource center.

Author(s)

Gregory G. Butler, CPA
Partner
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