By Gregory S. Dowell
May 4, 2020
The IRS is lost again without a compass. With many businesses hanging on to to their financial lives by a thread, the IRS has decided to interpret the CARES Act in a way that was not intended by lawmakers. In its recently released Notice 2020-32, The IRS indicates that a business receiving a Paycheck Protection Program Loan (PPPL), which contains a clause for forgiveness if certain payroll and other expenses are incurred in the first 8 weeks following funding, may be in for a surprise. The IRS says that the expenses incurred by the business that are subsequently forgiven are NOT deductible by the business. In coming to this conclusion, the IRS applies Internal Revenue Code Section 265, which says basically that a deduction is not allowable if the expenses are allocable to income that is exempt from taxation. The purpose of Section 265 is to prevent a taxpayer from deducting expenses incurred to earn tax-exempt income; it’s intended to prevent a double-deduction. Another example would be that a business is not allowed to deduct an expense that is subsequently reimbursed. The Code Section is entirely logical; it’s the application of the Code Section to this situation that the IRS has managed to completely mangle.
The CARES Act is a bit of a marvel. It came together very quickly to respond to the crisis created by the pandemic. Anything written that quickly is bound to be a less-than-perfect document, but to nitpick it’s inadequacies would be short-sighted. As is the case with any legislation, even legislation that is debated and honed over much longer periods of time, it is important to look to the intent of the lawmakers. In this case, the lawmakers emphasized that they were giving a huge break to businesses by making the forgiveness of the PPPL nontaxable. Based on the IRS’ interpretation, there is no break to business offered by the law; a business simply has an offsetting transaction if the forgiven loan disallows the payroll and other expenses incurred. It was clearly the intent of the law to allow businesses to deduct the expenses and NOT claim the forgiven debt. Why else would lawmakers claim there was a benefit to businesses?
The IRS does this occasionally – it runs off the rails with an interpretation from time to time. The AICPA, the professional society of CPAs, is making a legislative protest to force the IRS to restate its position. Let’s hope that the lawmakers reflect back on their intent in the Act and give the IRS a stern warning to get its “act” together.