On March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and Economic Securities (CARES) Act, a $2.3 trillion relief package designed to help individuals and businesses manage the damage caused by COVID-19.
The most appealing program included in the CARES Act was the creation of the PPP, a new loan program under Section 7(a) of the Small Business Act that injected nearly $600 billion into small businesses to pay employee wages and other critical expenses like rent and utilities for an 8 week period.
Millions of businesses rushed to apply for a PPP loan, because doing so would not add debt to their business since the PPP loans are loans in name only; once a borrower receives the funds, the amount spent over the next 8 weeks on payroll, rent and utilities is eligible to be forgiven.
Additionally, cancellation of debt typically creates taxable income under Section 61(a)(11) of the Internal Revenue Code, the CARES Act specifically provided that forgiveness of a PPP loan is tax-free. The IRS has since objected to the tax-free forgiveness with the issuance of Notice 2020-32 appling section 265, which explains that expenses “allocable to tax-exempt income” are not deductible by the payor. This means any expenses paid by a borrower that are ultimately forgiven by the lender on a tax-free basis will not be deductible on the borrower’s 2020 tax return. This rule is intended to prevent a borrower from double-dipping by receiving both a tax deduction and tax-free forgiveness related to payment of the same expenses it was a surprise to many borrowers, who had expected for both tax-free treatment and a deduction based on their reading of the CARES Act and statements from politicians when the Act was passed. Congress is currently considering a one-page amendment to Section 265 of the Tax Code to specifically permit a deduction related to the PPP loan expenses, but for now no deduction is allowed.
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