The recent avalanche of SBA loans being made under the CARES Act is designed to assist small businesses to survive the economic destruction being wrought upon us in the name of fighting off the Wuhan Caronavirus pandemic. One of these loan programs, the Paycheck Protection Plan (PPP) loan is popular because besides being a very favorable 1% loan, it has a grant feature that includes being forgiven if the proceeds of the loan are spent on certain expenses, primarily payroll and payroll-related costs.
You can imagine the demand for such a loan. Borrow at a paltry 1%, and if you spend 75% of it on wages and related costs and the rest on rent and insurance, you don’t have to pay it or the interest back. It converts to a grant and is forgiven, tax-free! If you think that’s not a game-changer, ask any banker what they’ve been doing lately… 😊
The grant feature has been widely touted as tax-free. There will be no cancellation of indebtedness income for the portion of the loan qualifying as a grant. Yippee, Free Money!
Enter Scrooge McIRS. Recently the IRS issued a public notice www.irs.gov/pub/irs-drop/n-20-32.pdf that explains that yes, the grant is tax-free for Federal Income Tax purposes. HOWEVER, any costs paid for with tax-free income cannot be deducted as expenses against taxable income pursuant to IRC Sec 265. Since the loan only qualifies as a grant if it is spent on costs that would otherwise have been deductible, the disallowance of a deduction for these costs essentially puts a taxpayer in the same position as if the proceeds had been taxable income and spent on deductible expenses. I.E., no taxable income on the proceeds and no deduction on what it was spent on is the same as taxable income on the proceeds and full deduction for what it was spent on. No difference.
What the SBA and Congress giveth, the IRS taketh away.
I think there will be some howling about this, but I don’t see it changing. It will literally take an act of Congress to change the IRS’ position on this one, and we all know how likely that is.