INSIGHTi
IRS Guidance Says No Deduction Is Allowed
for Business Expenses Paid with Forgiven PPP
Loans
Updated December 10, 2020
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act; P.L. 116-136) created Smal
Business Administration (SBA) Paycheck Protection Program (PPP) loans for payroll expenses and
certain operating costs, which are forgiven if the borrower meets certain criteria.
On April 30, 2020, the Internal Revenue Service (IRS) issued Notice 2020-32, stating that PPP recipients
cannot claim a deduction for expenses funded from forgiven PPP loans.
PPP Forgiveness
Borrowers can apply for forgiveness on the principal and accrued interest if the borrower maintains
employment and limits wage decreases.
In general, forgiven debt—“cancel ation of indebtedness income” or CODI—is subject to income
taxation, unless specifical y excluded. Section 1002 of the CARES Act excludes forgiven PPP loan
amounts.
Tax Deductibility of Business Expenses
The CARES Act has no language on the deductibility of PPP expenses. Under Internal Revenue Code
(IRC) Sections 162 and 163, taxpayers can deduct ordinary or necessary business expenses. However,
IRC Section 265(a)(1) states that an expense cannot be deducted if it is al ocable to income exempt from
taxation.
Double Benefit
A “double benefit” arises when a taxpayer receives tax-free income (like a forgiven loan) and is also able
to claim a tax benefit (like a deduction or a credit) using that income. For example, assume a taxpayer
faces a top marginal income tax rate of 37% and takes out a PPP loan for $100,000 that is forgiven by the
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lender and not subject to tax. The first benefit is a tax-free grant of $100,000. If the taxpayer can also
deduct the loan amount as business expenses, a second benefit is $37,000 in tax savings ($100,000 *
37%).
If Congress meant to disal ow this “double benefit,” a question can be raised as to why the exclusion of
the loan forgiveness was explicitly provided in the legislation. To il ustrate, Table 1 assumes a $100,000
forgiven loan, $100,000 of deductible expenses, and a 37% tax rate. The normal treatment in the tax code
(the forgiven loan is taxable, and the associated business expenses paid from that loan are deductible)
would generate a $37,000 tax liability from that taxation of the CODI (scenario 1). But that amount would
be entirely offset by a $37,000 tax savings from deducting the business expenses. Excluding the forgiven
loan results in no tax on the income, but al owing deductions provides a tax saving of $37,000 (scenario
2). If, however, the forgiven loan is not taxed and deductions are disal owed, there is no tax on the income
or benefit from the deduction. Including the loan in income and al owing deductions (scenario 1) leads to
the same outcome as excluding the loan and disal owing deductions (scenario 3). Hence, one could argue
that this exclusion was included in the law because it was Congress’s intent to provide this additional
benefit.
Table 1. Hypothetical Example of Tax Effect
of Disallowing Deductions for Business Expenses on PPP Loans
Tax Savings from the
Tax Scenario
Tax On Income
Deduction
Net Tax Effect
1. Normal Tax Treatment
$37,000
-$37,000
0
2. Treatment w/ Exclusion on Forgiven
Debt
0
-$37,000
-$37,000
3. Treatment w/ Exclusion on Forgiven
Debt and No Deduction
0
0
0
Source: CRS calculations, assuming a $100,000 forgiven loan, $100,000 in deductible business expenses, and a 37% tax
rate.
IRS Guidance
IRS Notice 2020-32 (April 30, 2020) disal ows deductions for expenses paid for by forgiven PPP loans.
Tax filers may need to amend quarterly filings or might chal enge this decision in court, although the
outcome is not clear. IRS Rev. Rul. 2020-27 (November 18, 2020) states that a taxpayer cannot deduct
expenses paid in 2020 if they “reasonably expect” those expenses to be forgiven at a later date. IRS Rev.
Proc. 2020-51 (November 18, 2020) provides a safe harbor for PPP borrowers whose loan forgiveness has
been denied in part or full, and who wish to file an amended return to claim business deductions.
Some policymakers have expressed concerns with IRS’s position, including the chairs of the House Ways
and Means and Senate Finance Committees, who have stated that IRS’s interpretation is contrary to
congressional intent. The ranking member on the Ways and Means Committee, however, has stated that
there was not a clear congressional intent to al ow a deduction.
Treatment in Revenue Estimates
According to media reports, the Joint Committee on Taxation indicated in a July 27, 2020, letter to
Senator John Cornyn that the revenue estimate for the CARES Act was consistent with its interpretation
of the intent of al owing deductibility of expenses, and that legislation affirming the deductibility of
expenses would have no revenue effect.
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Economic Benefit of PPP Loans
IRS’s position would reduce the economic benefit of PPP loans to taxpayers. Businesses could lay off
employees and not apply for PPP loan forgiveness. With that said, businesses could stil find PPP loans
are the most preferable option for short-term economic relief compared to alternative COVID-19
assistance measures.
Options for Congress
If Congress decides that Section 265(a)(1) should be waived for business expenses funded by forgiven
PPP loans, it could enact legislation. Congress has enacted exemptions, such as IRC Section 265(a)(6)
(mortgage interest and property taxes deductible on a home receiving a tax-free military housing
al owance or a parsonage al owance for religious clergy). The Safeguarding Smal Business Act (S. 3596),
the Heroes Act (H.R. 6800), the Smal Business Expense Protection Act (H.R. 6821; S. 3612), and the
Safeguarding Smal Business Act (S. 3596) would amend the CARES Act to al ow taxpayers to receive
PPP loan forgiveness without affecting their ability to claim expense deductions. An updated version of
the Heroes Act (H.R. 925), which al ows deductibility, passed the House on October 1. The December 9,
2020, summary of the Bipartisan Emergency COVID Relief Act of 2020 proposes deductibility.
Author Information
Sean Lowry
Jane G. Gravelle
Analyst in Public Finance
Senior Specialist in Economic Policy
Disclaimer
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