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Our attorneys stay on top of changes in legislation, agency regulations, case law, and industry trends—then craft timely legal alerts to keep clients up to date on legal developments important to their business.

May 4, 2020

COVID-19: IRS Closes Door That Seemed Ajar Under PPP

The Coronavirus Aid, Relief, and Economic Security (CARES) Act established the Paycheck Protection Program (PPP), which calls for forgivable loans to be made to eligible businesses.

Specifically, the PPP allows loans of up to $10 million at 1-percent interest to employers with fewer than 500 workers to cover two months of payroll and overhead. If an employer receiving a loan keeps its workers and does not reduce their wages, the government will forgive most or all of the loan. 

The loan amounts will be forgiven as long as:

  1. The loan proceeds are used to cover payroll costs and most mortgage interest, rent, and utility costs over the eight-week period after the loan is made
  2. Employee and compensation levels are maintained

The loan forgiveness will be reduced if a recipient decreases the number of full-time employees. In addition, the loan forgiveness will be reduced if the recipient decreases salaries and wages by more than 25 percent for any employee that made less than $100,000 (determined on an annualized basis) in 2019. Loan recipients have until June 30 to restore full-time employment and salary levels for any changes made between February 15 and April 26.

The added attraction of the PPP is that there is no forgiveness of debt income for tax purposes when the loan is forgiven. This tax-free nature of the loan proceeds is contrary to normal circumstances where a business would have to report taxable income if the business is relieved of paying back debt.

What had been unclear under the CARES Act was whether recipients of a loan under the PPP were entitled to claim a tax deduction for the expenses paid using the loan proceeds if the loan is forgiven. The CARES Act did not appear to prohibit a deduction.

Under traditional tax principles, however, the consequences seemed too good to be true that a loan recipient could receive free money, not have income when the loan is forgiven, and still be able to deduct payments of wages and rent that were made with the free money.

By issuing Notice 2020-32, the IRS just confirmed that “if it is too good to be true, it probably is” Under the notice, to the extent the CARES Act operates to exclude loan proceeds from a recipient’s income when the loan is forgiven, a deduction for the expenses that are paid using the loan proceeds is disallowed. The IRS based its conclusion set forth in the notice on Section 265 of the Internal Revenue Code, which disallows deductions for any amount otherwise allowable as a deduction if the deduction is allocable to one or more classes of income (other than interest) that is wholly exempt from income taxes.

It appears that Congress may step in to reverse the conclusion reached by the IRS in Notice 2020-32.

If you have any questions regarding the content of this alert, please contact Gerry Stack, Tax Practice Area chair, at gstack@barclaydamon.com; Nick Scarfone, partner, at nscarfone@barclaydamon.com; or another member of the firm’s Tax Practice Area.

We also have a specific team of Barclay Damon attorneys who are actively working on assessing regulatory, legislative, and other governmental updates related to COVID-19 and who are prepared to assist clients. You can reach our COVID-19 Response Team at COVID-19ResponseTeam@barclaydamon.com.

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