By Timothy J. Eifler
LOUISVILLE, Kentucky – Despite the initial threat of a veto, on December 27, 2020, President Trump finally signed the Consolidated Appropriations Act, 2021, a combined COVID-19 relief / government spending plan. This extensive law also includes the “COVID-related Tax Relief Act of 2020” (the “Discharge Act“) Which, among other things, overrides previous IRS guidelines and confirms that expenses paid with PPP loan proceeds are deductible even if the loan is waived later.
Business expenses are generally deductible. These are not expenses that are paid or reimbursed by others. Section 265 (a) of the Internal Revenue Code similarly effects these general principles by prohibiting taxpayers from deducting expenses funded by tax-exempt income.
These characteristics of US income tax are based on the general guideline that there would be an undue double tax benefit if untaxed income were to generate deductible expenses.
The Coronavirus Aid, Aid and Economic Security Act (“CARES law“) The paycheck protection program (“PPP“) As a new loan program administered by the US Small Business Administration. The PPP is designed to help small businesses adversely affected by the COVID-19 emergency pay for certain business expenses. PPP loans are forgivable to the extent that recipients find that the funds will be used to pay payroll, rent, utilities, and other qualified expenses for a period of time after the proceeds are received.
The forgivable nature of PPP payments would normally raise questions about the taxation of these funds – debt relief generally results in the amount waived being included in the taxpayer’s gross income. The CARES Act overrides this general tax rule. The CARES law provides that PPP loans granted are excluded from gross income. (See Section 1106 (i) of the CARES Act).
Shortly after the PPP came into effect, taxpayers asked questions about the deductibility of expenses funded by PPP loans when the loans are waived. In response, the IRS was quick to issue the 2020-32 notice. Expenses that are financed with waived PPP loans are therefore not deductible, as they would otherwise result in a double taxation advantage.
This notice left the question of whether expenses in the 2020 tax year are deductible if the loan were not waived until 2021. IRS in Revenue Ruling 2020-27 later stated that if a taxpayer “reasonably expects” the loan to be waived, the taxpayer cannot deduct the expense regardless of when the loan is actually waived.
The Relief Act undermines the IRS’s anti-taxpayer guidelines by making it clear that expenses remain deductible even if funded by a PPP loan made. Section 276 of the Discharge Act states that “[f]or purposes of the 1986 Internal Revenue Code … due to exclusion from gross income [the loan forgiveness provision that states forgiven PPP loans are not income]. “
Owners of partnerships and S-corporations receive their share of the excluded income in their units / shares. Section 276 deals with special partnership item allocations by requiring that the allocation of tax-exempt income follow the allocation of related deductible expenses. This provision applies to all tax years ending after the entry into force of the CARES Act.
Timothy J. Eifler is a tax specialist at Stoll Keenon Ogden PLLC.