CARES Act Expenses are Deductible!

Take-Away: Congress surprised us and reversed the IRS’s initial position that while PPP loans used to pay business expenses that are reimbursed under the CARES Act will be forgiven, those business expenses are not tax deductible. That all changed with the recent Consolidated Appropriations Act.

Source: Revenue Ruling 2021-2

Background: In IRS Notice 2020-21 (May 18, 2020) and Revenue Ruling 2020-27 (December 7, 2020) the IRS announced that taxpayers (eligible recipients) could not deduct certain otherwise deductible business expenses to the extent that the payment of those expenses resulted (or is expected to result) in the forgiveness of a loan guaranteed by the SBA under the Paycheck Protection Program (PPP.)

• Loan (Debt) is Forgiven: The CARES Act provides for the forgiveness of covered loans. [Section 1106(b).]
• Forgiven Debt is Not Taxable as Income: The CARES Act provides that for purposes of the Internal Revenue Code, any amount that otherwise would be includible in an eligible recipient’s gross income by reason of the forgiveness of the PPP indebtedness, is to be excluded from the eligible recipient’s gross income. [Section 1106(i).]

Consolidated Appropriations Act of 2021: Section 1106(i) of the CARES Act was re-designated and transferred to the Section 7A(i) of the SBA. That Section was amended by the Economic Aid to Hard-Hit Small Business, Nonprofits, and Venues Act (Title III of Division N of the Consolidated Appropriations Act of 2021.) The Appropriations Act provides that:

• (i) Forgiven Debt Not Taxable Income: No amount of the PPP loan will be included in the gross income of the eligible recipient by reason of the debt forgiveness;
• (ii) Business Expenses are Deductible: To the extent the PPP loan was used to pay business expenses, no income tax deduction will be denied for those business expenses;
• (iii) Tax Attributes Preserved: Even though the PPP loan proceeds are ultimately forgiven, no tax attribute will be reduced or denied; and
• (iv) Tax Basis Increased: Loan proceeds used to acquire or improve business assets will have their income tax basis increased even though the loan proceeds are later excluded from the borrower’s gross income.

The result of the 2021 Appropriations Act is to make Notice 2020-32 and Revenue Ruling 2020-27 obsolete.

Conclusion: Taken together, a PPP loan greatly benefits the small business borrower. The SBA guaranteed loan is ultimately forgiven. However, the forgiven debt is not reported as taxable income to the borrower, which is the general rule when a debt is forgiven. If the borrowed PPP funds are used to pay business expenses, those expenses may still be deductible to off-set other taxable income, leading to lower taxable income for the borrower. If the PPP loan proceeds are used to acquire or improve a business asset, that asset’s basis is increased, either leading to larger future depreciation deductions by the borrower, or lowering the borrower’s exposure to capital gain taxes if that business asset is later sold (with a higher tax basis.) What’s not to like?