May 4, 2020Client Alert

IRS Notice 2020-32: Deductions Disallowed When CARES Act PPP Loans are Forgiven

Under § 1106(i) of the CARES Act, certain amounts forgiven under the Paycheck Protection Program (PPP) are excluded from a taxpayer’s gross income.[1] Since the enactment of § 1106(i), however, there has been considerable debate as to whether amounts spent for permissible purposes with PPP proceeds might not be deductible for federal income tax purposes if and to the extent the PPP loan is forgiven. The fundamental concern has been whether the IRS would take the position that expenses paid with proceeds from tax-exempt income are nondeductible. For example, assume a taxpayer receives a $100,000 PPP “loan,” and all the proceeds are used for permissible purposes, which otherwise are deductible for federal income tax purposes. Under § 1106(i) of the CARES Act, we know that under certain circumstances the $100,000 loan, when forgiven, will be excluded from the taxpayer’s gross income. But what about the $100,000 in expenses, which in this example are ordinarily deductible? Will these expenses now be deemed nondeductible because they were paid with proceeds excluded from gross income?

On April 30, 2020, the IRS issued Notice 2020-32, which takes the position that such expenses are not deductible. The IRS view is that under § 265 of the Internal Revenue Code (the “Code”), taxpayers would receive a prohibited “double benefit” by deducting expenses paid with tax-exempt proceeds. Thus, in the above example, the $100,000 in expenses would be nondeductible. Note that, in a conceptual sense, § 1106(i), although obviously enacted as a relief provision (to exclude the forgiven loan from gross income), might provide no relief at all under the IRS position. That is, if § 1106(i) had not been enacted, taxpayers would not have had the income exclusion, but typically would then have been entitled to deduct the expenses. In the typical case, this would be no different than if the forgiven loan is excluded from income under § 1106(i), but the expenses are nondeductible.

In any event, under the CARES Act, payments that could result in forgiveness of a PPP loan include those made for the following expenses incurred during the eight-week “covered period” beginning on the PPP’s origination date (each, “an eligible CARES Act § 1106 expense”): (1) payroll costs, (2) any payment of interest on any covered mortgage obligation, (3) any payment on any covered rent obligation, and (4) any covered utility payment.[2]

Consider the following scenario: Business A receives a PPP loan and uses that loan to pay its employee payroll costs. The amount of the loan spent on payroll during the first eight weeks after the loan origination is forgiven under the terms of the PPP, and pursuant to the special exception created by the CARES Act, the amount of that forgiven debt is excluded from Business A’s gross income for 2020. In calculating its 2020 federal income tax liability, Business A deducts expenses incurred in its trade or business, including all normally deductible payroll costs for the year (including those paid for with the PPP loan), thereby reducing its taxable income and federal income tax liability. According to the IRS, this amounts to a double benefit for Business A: the payroll expenses paid for with the PPP loan are deducted to reduce taxable income, but the income used to pay those expenses was not taxable income in the first place.

Under the IRS view, § 265 of the Code kicks in to prevent Business A from enjoying this purported double tax benefit by disallowing Business A’s deduction of the portion of its payroll expenses incurred during the eight-week “covered period.” Notice 2020-32 does not create new law; rather, it states the IRS position that the existing provisions under § 265 apply to prevent a “double benefit.” 

Recipients of a PPP loan should closely track any expenses that they would normally deduct under § 162 of the Code as trade or business expenses or under § 163 as interest expenses during the 8-week “covered period” beginning on the PPP’s origination date. Under Notice 2020-32, payments that result in forgiveness of the PPP (i.e., eligible CARES Act § 1106 expenses), must be subtracted from the total deductions claimed for 2020.

While a reasonable interpretation of existing tax law, note that the IRS position is politically controversial. It has been reported that at least some members of Congress are disappointed with the IRS position in Notice 2020-32, and may address this issue in subsequent legislation.[3] We will be carefully monitoring this issue and provide updates with respect to future developments.

[1] Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136, 134 Stat. 281, 286-93 (March 27, 2020).

[2] The terms “covered period,” “covered mortgage obligation,” “covered rent obligation,” “covered utility payment,” and “payroll costs” are defined in Section 1106(a) of the CARES Act. 

[3] See, e.g., Lydia O’Neal, “Loan Forgiveness Deductions Left in Hands of Congress,” Bloomberg Tax (May 1, 2020), available at

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