By: Lynn K. Ching
Many small businesses received a loan in 2020 under the (CARES Act) SBA Paycheck Protection Program (“PPP”). Under the CARES Act, the PPP loan proceeds are eligible for forgiveness, if used to pay (1) payroll costs, (2) certain employee benefits relating to healthcare, (3) interest on mortgage obligations, (4) rent, (5) utilities, and (6) interest on any other existing debt obligations, during the ‘covered period’. The CARES Act also excludes forgiven PPP loan proceeds from taxable income.
However, the CARES Act did not specifically address whether business expenses paid with a (forgivable) PPP loan may be deducted on a taxpayer’s federal tax return.
Federal
Not missing a beat, in May 2020, the IRS issued Notice 2020-32, which stated that no deduction is allowed if its payment results in the forgiveness of a (PPP) loan.
When faced with blowback from Congress stating that disallowing the business deductions would negate the intent of Congress to assist floundering small businesses, the IRS dug its heels in and issued Revenue Ruling 2020-27, amplifying its position in Notice 2020-32 that business expenses paid with PPP loans (and resulting in forgiveness of the PPP) are not tax deductible.
Thankfully, on December 27, 2020, and as part of the $900 billion COVID-19 relief economic package passed by Congress, the CARES Act was amended so that “…no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income provided by § 7A(i)(1) of the SBA.”
In short, Congress prevailed (over the IRS), and as a result taxpayers may deduct business expenses covered by their PPP loan, even if the loan qualifies for forgiveness.
Begrudgingly I’m sure, the IRS then issued Revenue Ruling 2021-2, stating that in view of the changes to the CARES Act, Notice 2020-32 and Rev Ruling 2020-27 were obsolete.
State of California
For taxable years beginning on or after January 1, 2020, California conforms with federal law and provides an exclusion from gross income for loan amounts forgiven under the PPP. See R&TC Section 17131.8.
While California has not yet completely conformed with federal law allowing 100% of tax deductions for PPP covered expenses, as of February 2021, Governor Newsome and legislators reached an agreement to allow $150,000 in PPP business deductions.
Lynn K. Ching is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Lynn may be reached at (415) 318-3990 or by email at lching@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.