8561 / What are the tax consequences of loan forgiveness under the paycheck protection loan program?
Under normal circumstances, when a loan or debt is forgiven, the income is included in the debtor’s income under cancellation of debt principles. Paycheck protection loans, however, were excluded from these generally applicable rules—meaning that amounts forgiven were not included in the recipient’s income when forgiven.
Late in 2020, Congress clarified that business owners were entitled to their typical business deductions even if the expenses were paid out of loan proceeds that were forgiven.2 This overrides earlier IRS guidance contained in Notice 2020-32, which provided that otherwise allowable deductions were to be disallowed if the payment of the expense (1) resulted in loan forgiveness under the PPP loan program and (2) the income associated with the loan forgiveness was excluded from income under CARES Act Section 1106(i).
Expenses like salary, rent, mortgage interest and utilities are generally deductible as ordinary and necessary business expenses under IRC Section 162. These were also exactly the types of expenses could be incurred in order for a business to receive loan forgiveness under the CARES Act.
Planning Point: The 2020 year-end stimulus package clarified that federal tax deductions were be available even if the business used PPP loan proceeds that were forgiven to cover the expenses. However, state tax issues may still arise. While some states, like New York and Illinois, generally conform to federal laws on these issues, others do not. For example, Kentucky and North Carolina both announced that for state income tax purposes, business expense deductions were not allowed if the expenses were paid for with forgiven PPP loan funds. Small business clients should make sure to pay close attention to changing local laws on this subject when determining whether to seek loan forgiveness.
Original IRS Safe Harbor Rules