On April 30, 2020, the IRS issued Notice 2020-32 in which they indicated that taxpayers whose Paycheck Protection Program (“PPP”) loans are forgiven will not be able to deduct expenses for which forgiven loan proceeds were used.
This notice came as a surprise to many, as the overwhelming feeling amongst interested parties was that this disallowance of deduction was not the intention of Congress. The CARES Act does not specifically address the deductibility of such expenses, but does indicate that forgiven PPP loan proceeds “shall be excluded from gross income.” By disallowing deductions paid for by forgiven PPP loan proceeds, the IRS has, in effect, made the receipt of PPP loan forgiveness a taxable event.
Because Notice 2020-32 seems to fly in the face of the CARES Act and the perceived intent of Congress, there has been speculation that Congress would overturn the IRS’ position. However, six months after the issuance of the notice we find ourselves in the same position as before, despite the words and efforts of some of the country’s lawmakers.
There has been some belief that a fix would be included in the next legislative response to COVID-19, and the most recent legislation passed by the House on October 1 (the Heroes Act) contained language allowing deductions paid for by forgiven PPP loan proceeds. However, the Heroes Act in its current form is unlikely to be signed into law, and the current stalemate between Speaker Pelosi and Treasury Secretary Mnuchin as it relates to an economic stimulus package leaves many wondering what to do in the interim.
Assuming the IRS’ position holds, there is a question of timing for which there is no official guidance. The vast majority of businesses will have used their PPP loan proceeds in an initial tax year but will not receive a decision on loan forgiveness until a subsequent tax year. In this scenario, questions arise as to when to disallow deductions for tax purposes and how to account for the loan itself. It is worth noting that taxpayers with fiscal year-ends such as June 30 or September 30 have been forced to face this uncertainty earlier than calendar-year taxpayers.
The AICPA, in conjunction with the FASB, released guidance on accounting for forgivable PPP loans in Technical Question and Answer (TQA) 3200.18. In this document, applicable to nongovernmental entities only, they indicate that a company should continue to record the proceeds from the loan as a liability until either (1) the loan is partly or wholly forgiven and the debtor has been legally released, or (2) the debtor pays off the loan. If the loan is eventually forgiven, the guidance suggests that the company should record a gain on extinguishment of debt.
If a company were to follow the book treatment recommended above for tax purposes, there would be no impact to a company’s taxable income until the forgiveness determination is made. For example, if a calendar-year taxpayer has a PPP loan that is forgiven in 2021, that taxpayer would not disallow any deductions on their 2020 tax return but instead would record the disallowance on their 2021 tax return. This would follow the treatment for financial statement reporting and would avoid the recording of book/tax differences in both 2020 and 2021.
The hope is that final guidance can be provided for taxpayers who find themselves in the situation described above. It is the author’s opinion that Congress will eventually overturn the IRS’ position in Notice 2020-32, and that expenses paid for by forgiven PPP loan proceeds will be fully deductible. Until then, it is reasonable to conclude that the logic of the accounting guidance released by the AICPA and FASB could also be applied for income tax purposes.
For more assistance with PPP deductions, contact your Larson advisor today.