In the absence of final guidance, true loan-forgiveness benefits are unknown.
The roll out of the Paycheck Protection Program loans triggered a rush for funding at the end of March. The $349 billion in funding for the program provided by the Coronavirus Aid, Relief, and Economic Security (CARES) Act ran out mid-month, and President Trump signed a stopgap measure to provide an additional $320 billion in funding on April 24.
The CARES Act expanded existing loan programs offered by the Small Business Administration (SBA), including the 7(a) and 7(b) loan programs. Generally, SBA loans provide more flexible lending arrangements to smaller organizations that may have a harder time accessing capital from traditional lenders. Congress intended the PPP loans, an SBA 7(a) loan expansion, to support employee retention among organizations with 500 or fewer eligible employees. PPP loans can be borrowed in amounts that are the lesser of 2½ times an organization’s monthly payroll costs for the past 12 months or $10 million.
The loan will be forgiven to the extent organizations demonstrate PPP loan funds supported qualifying payroll functions during an eight-
week period beginning on the date the loan is funded as well as rent, utilities and mortgage interest. The amount of forgiveness is first limited by requiring 75 percent of the forgiven portion be payroll costs.
Additionally, the forgiveness amount will be reduced in the event the employer does not restore headcount or payroll costs to pre-pandemic levels before June 30, 2020. In the event the employer does not restore headcount or payroll costs to pre-pandemic levels, the amount of loan forgiveness is proportionally reduced by the headcount reduction and payroll cost reductions in excess of 25 percent.
The unforgiven balance is due two years after the loan origination date and accrues interest at a rate of 1 percent. Tax treatment of the loan proceeds Initially, many believed the forgiveness of the PPP loans would be tax free. Section 1106(i) of the CARES Act states: “TAXABILITY – For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.”
Many people read that and conclude that the forgiveness is not taxable. Congress went out of its way to include this language. However, as the Internal Revenue Service points out in Notice 2020-32, the CARES Act in fact excludes the forgiveness from income, but does not address Internal Revenue Code Section 265, which provides that no deduction is allowed to a taxpayer for any amount otherwise allowable as a deduction to such taxpayer that is allocable to one or more classes of income wholly exempt from the taxation.
The Notice goes on to cite tax cases and authority that says tax exempt income earmarked for specific purposes and deductions directly reduce the basis in the specific purposes and any corresponding deductions. So, while the income is not taxable, the associated expenses used to determine forgiveness are not deductible. It is important to note, this IRS guidance, while well-reasoned, is a General Counsel Memorandum.
A 2010 court case states that a GCM is treated as an informal document that provides the chief counsel’s opinion on particular tax matters before other IRS officials. The GCM is entitled to some deference, although it does not have the force of law because it is not generally subject to notice and comment.
That said, this particular GCM has a well-reasoned discussion of the tax law that taxpayers will have troubles overcoming without further guidance from Treasury or the Internal Revenue Service. The AICPA strongly opposes the IRS’ interpretation of denial of deductions related to loan forgiveness.
The chair of the AICPA Tax Executive Committee is on record saying “In effect, the IRS guidance means that the taxability provisions (Section 1106(i) have no meaning. Why waste the ink to say that for purposes of the code, the loan forgiveness is not includible in income, if the government will just take away deductions in the same amount?”
Accordingly, the AICPA is pursuing further legislative clarity. Conclusion Unfortunately for taxpayers, the current state of affairs is unknown. Without further guidance in favor of taking the related deductions, taxpayers will find it challenging to overcome GCM’s logic in Notice 2020-32, leaving taxpayers uncertainty as to the true benefit of the PPP loan-forgiveness provisions.
Additionally, at this point, the issue will likely become a political issue, which may further delay and complicate clarity for the taxpayer.