The Department of Treasury has clarified that businesses may not deduct any expenses which are used to obtain loan forgiveness under the Paycheck Protection Program (“PPP”). Under the PPP, borrowers may obtain forgiveness of a PPP loan from the SBA to the extent that the funds are used towards qualifying expenses such as payroll and rent. Under ordinary circumstances, “discharge of indebtedness” is considered taxable income. In other words, if a party obtains forgiveness or discharge of a loan obligation, they are, absent insolvency or other extraordinary circumstances, taxed on the amount of the loan that was discharged.¹ Under the CARES Act, however, businesses are not taxed on forgiveness of PPP loans.
The regulation clarifies that a borrower who obtains forgiveness based upon qualifying expenses may not deduct the same expenses on their tax return. Without this clarifying regulation, a borrower-taxpayer could receive a double tax benefit, on top of the generous loan forgiveness provided by the Government. This new regulation closes a loophole which would have resulted in this tax windfall. This rule is consistent with a previous statutory provision that prevents taxpayers from deducting for expenses that are attributable to nontaxable income. United States Department of Treasury, Notice 2020-32, Pages 4-5 (citing Section 265 of the Tax Code).
¹This prevents parties from, for example, structuring a transaction as “working off a loan” rather than ordinary payment for ongoing services to evade taxation.