It has been more than eight months since the enactment of the CARES Act,[i] yet here we are, with the end of 2020 in sight, and we are still debating whether taxpayers should be allowed to claim a deduction for business expenses that were properly paid using the proceeds of a loan under the Paycheck Protection Program.[ii] Why is that?

Two reasons: (1) The IRS; and (2) The Congress. The IRS has inexplicably ignored Congressional intent, while the Congress has irresponsibly allowed the IRS to do so.


Just over one month after the enactment of the CARES Act, the IRS issued Notice 2020-32 (the “Notice”),[iii] in which it purported to “clarify” that no deduction would be allowed to a business for its payment of an otherwise deductible expense if (i) the payment was made using the proceeds of a PPP loan,[iv] (ii) such loan was ultimately forgiven by the SBA and, (iii) in accordance with the terms of the CARES Act, the income associated with such forgiveness was excluded from the gross income of the business.[v]

According to the IRS, no deduction is allowed to a taxpayer for an otherwise deductible expense that is allocable to a class of income that is excluded from the taxpayer’s gross income or that is exempt from income taxes. In this way, the IRS explained, the Code seeks to deny the taxpayer a double tax benefit: the deduction of the payment made with the loan proceeds and the subsequent exclusion of such loan proceeds from gross income notwithstanding the forgiveness of the loan.

The Notice conceded that although the CARES Act spoke directly to the exclusion of the forgiven PPP loan from the taxpayer-borrower’s gross income, it did not specifically address whether the taxpayer-borrower would still be allowed to claim a deduction for the “eligible expenses”[vi] paid with the subsequently forgiven loan proceeds.[vii]

The IRS, however, concluded that to the extent the CARES Act operates to exclude from a taxpayer’s gross income the amount of a forgiven PPP loan, it results in a “class of exempt income;” thus, the Code disallows any otherwise allowable deduction for expenses paid by the taxpayer with the forgiven loan.

As discussed below, the agency recently reaffirmed its position.

The Congress

It did not take long for Congress to react to the Notice.

Within four days of its publication, a bipartisan group of Senators introduced “The Safeguarding Small Business Act” (S. 3596) for the sole purpose of ensuring the deductibility of any expenses paid or incurred in accordance with the PPP program.[viii]

One day later, the Democratic Chair of the House Ways and Means Committee, together with the Republican Chair of the Senate Finance Committee, wrote to Secretary Mnuchin to express their disappointment with the IRS’s position:

“[W]e are writing to express our concern with the position taken by Treasury and the IRS in Notice 2020-32, which is contrary to congressional intent. Notice 2020-32 provides that otherwise deductible business expenses are not deductible if the taxpayer is the recipient of a Paycheck Protection Program (PPP) loan that is subsequently forgiven. We believe the position taken in the Notice ignores the overarching intent of the PPP, as well as the specific intent of Congress to allow deductions in the case of PPP loan recipients. . . .

“Providing assistance to small businesses, only to disallow their business deductions as provided in Notice 2020-32, reverses the benefit that Congress specifically granted by exempting PPP loan forgiveness from income. This interpretation means that whatever income a small business is able to produce will be taxed on a gross basis to the extent of the loan forgiveness, leaving substantially less after-tax capital for the swift economic recovery we hope is on the horizon.”

The Chairs went on to explain that the exclusion of PPP loan forgiveness from income was specifically included in the CARES Act to provide a tax benefit to small businesses that received the PPP loan. “Had we intended to provide neutral tax treatment for loan forgiveness,” the chairs continued, the Act’s forgiveness provision “would not have been necessary. In that case, loan forgiveness generally would have been added to the borrower’s taxable income, and the expenses covered by the PPP loan would be deductible, reducing taxable income by an offsetting amount and resulting in no additional net income. Notice 2020-32 effectively renders” the income exclusion provision meaningless, and “is contrary to the intent of  . . . the CARES Act.”

Also within five days of the issuance of the Notice, another bipartisan-sponsored bill was introduced in the Senate – as S. 3612, the Small Business Expense Protection Act of 2020 – and in the House – as H.R. 6821 – which would have added the following language to the end of Section 1106(i) of the CARES Act (which excludes the forgiven PPP loan from gross income): “. . . no deduction shall be denied or reduced, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income.”

The HEROES Act[ix] was introduced the following week, and passed the Democratic-controlled House on May 15, by-and-large along party lines.[x] This proposed economic stimulus package included a provision which read as follows: “notwithstanding any other provision of law, any deduction and the basis of any property shall be determined without regard to whether any amount is excluded from gross income under . . . section 1106(i) of the CARES Act.”

Then came a summer of wasted opportunities and political posturing,[xi] until an updated version of the HEROES Act[xii]  was passed by the House on October 1, with the same provision described above, effective for taxable years ending after the date of enactment of the CARES Act.

The IRS Missed the Mark

The folks in Congress weren’t the only ones chastising the IRS for its “guidance” as to the non-deductibility of expenses paid with forgiven PPP loans. Indeed, most of the business and tax communities were quite vocal in their disagreement with the conclusions drawn by the Notice.

The Code, they stated, permits taxpayers to deduct any ordinary or necessary trade or business expenses, which includes PPP-eligible expenses. Nothing in the CARES Act denied the borrower-business the ability to claim a tax deduction for legitimate and eligible expenses paid with the loan proceeds, even where the loan was forgiven.

They pointed out that, if Congress meant to disallow the so-called “double benefit,” a question could be raised as to why the exclusion of the loan forgiveness from income was explicitly provided for in the CARES Act at all.

The “normal” treatment under the Code would have included the forgiven loan in income (say, $X),[xiii] while the associated business expenses paid with that loan (also $X) would have been deductible: a wash for tax purposes ($X of income offset by $X of deductions).

Under the IRS’s interpretation, if the forgiven PPP loan ($X) is not taxed, is used in its entirety to pay otherwise deductible expenses ($X), and no deductions are allowed, there is no tax on the $X of income and there is no tax benefit from the $X of otherwise deductible expenses – in other words, another wash.

By contrast, if the forgiven loan ($X) is excluded from income, as provided by the CARES Act, there is no tax thereon, but a deduction is allowed for the expenses paid with such loan ($X) – which the Act did not restrict – the taxpayer is provided with a benefit in the form of tax savings – the offset of other income, or the increase of a net operating loss to offset future income – which Congress must have intended, and which is borne out by its reaction to the Notice.

Could Congress have intended the same outcome under the CARES Act as under the normal rules described above? In other words, why would – indeed, how could – the IRS overturn the tax effect of Congress’s decision to exclude a forgiven PPP loan from a taxpayer’s gross income?

Does the IRS’s position – that no deductions be allowed for expenses paid using the proceeds from a PPP loan that is ultimately forgiven – convert that loan forgiveness into a meaningless gesture?[xiv]

Did You Say Something?

In the face of criticism from Congress, and from the business and tax communities, Secretary Mnuchin indicated that Treasury would review its position. Earlier this month, at an ABA Tax Conference, IRS officials acknowledged that the agency had come under fire for its stance on the deductibility of expenses as set forth in the Notice. They also indicated that the IRS was considering the questions raised and whether additional guidance should be issued.[xv]

Rather than reversing its position and withdrawing the Notice, as many had urged it to do – thereby providing additional liquidity, in the form of immediate tax savings, to those businesses with forgiven PPP loans[xvi] – the IRS instead disregarded the criticism leveled at the Notice, dug in its heels, and issued Rev. Rul. 2020-27 in which the agency reaffirmed its earlier stance.[xvii]

Rev. Rul. 2020-27

The IRS considered two situations in Rev. Rul. 2020-27:

  • The first, in which the taxpayer received a PPP loan; used the expenses as required under the PPP and otherwise satisfied all requirements for forgiveness; applied for such forgiveness; but, as of the end of 2020, had not yet been informed that its loan was forgive; the taxpayer had a “reasonable expectation”[xviii] of “reimbursement” of the amounts expended – the forgiveness of the covered loan was foreseeable; and
  • The second, in which the same taxpayer decided to defer its application for forgiveness until 2021; the taxpayer knew the amount of its eligible expenses that qualified for “reimbursement,” in the form of covered loan forgiveness; the taxpayer had a reasonable expectation of reimbursement – as in the first situation, the forgiveness of the covered loan was foreseeable.

The IRS began by describing Notice 2020-32, in which it clarified that no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of a covered loan.

It then launched into a legal analysis in support of its position, which purports to be rooted in basic tax/economic principles, including the “economic risk” and “tax benefits” doctrines.[xix]

The IRS concluded that a taxpayer that received a PPP loan, and that paid or incurred certain prescribed expenses – that were otherwise deductible – may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the PPP loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the loan by the end of such taxable year.

Is the Ruling’s Tax Analysis Correct?

Assume a taxpayer has expenses of $Y but does not have the wherewithal to pay them; the taxpayer borrows the necessary funds of $Y from a commercial lender and is obligated to repay the loan; the expenses of $Y are paid; the taxpayer still has to satisfy the $Y loan.

The taxpayer has not been economically enriched. They borrowed $Y and have to repay $Y. The receipt of the loan does not represent income to the taxpayer because it did not result in an accretion of value to the taxpayer. It’s true that the expenses were satisfied using the loan proceeds, but the debt of $Y remains outstanding.

Recognizing that the taxpayer is at economic risk for the $Y of indebtedness, the Code permits the taxpayer to deduct the expenses paid using the borrowed $Y in determining its taxable income.

If the indebtedness is subsequently forgiven, the taxpayer experiences an accretion in value of $Y and, thus, has to include the amount of the forgiveness in its income for the year of the forgiveness (basically recapturing the earlier deduction).

What if the forgiveness of the loan is somehow excluded from the taxpayer’s gross income – say, because the forgiveness does not result in an accretion of value to the taxpayer?[xx] The Code demands a price in return for this exclusion; specifically, the taxpayer is required to reduce certain tax attributes, such as loss carryovers and the adjusted basis for property, beginning in the taxable year immediately following the year of the forgiveness.[xxi] In this manner, the taxpayer’s tax savings for the year in which the debt was forgiven are recaptured in later years.[xxii]

By contrast, assume the taxpayer receives a nontaxable “grant” (please humor me) of $Y for the purpose of paying off $Y of expenses; the taxpayer is not required to include the grant monies in income; the taxpayer uses the funds to pay off expenses of $Y.

In that case, the taxpayer has realized an increase in value of $Y: the expenses have been paid off, but there is no obligation to repay the $Y grant. Because the taxpayer is not at economic risk for the $Y – the $Y received was a grant as opposed to a loan – the Code may deny the taxpayer a deduction for the expenses paid.[xxiii]

So What’s Next?

Does it matter, when viewed out of context – meaning outside of what was intended by Congress in enacting the PPP – that the IRS’s analysis, as set forth in Notice 2020-32 and Rev. Rul. 2020-27, has some merit?

No, it does not.

For one thing, as we saw above, its analysis is not the only viable game in town. In fact the regime that governs the cancellation of indebtedness, generally, may be better suited.[xxiv]

In any case, the fact remains that the respective Chairs of the House Ways and Means and Senate Finance Committees, one a Democrat and the other a Republican, have informed the IRS that its guidance is inconsistent with what Congress intended.

It is also a fact that several bipartisan bills have been introduced in the House and in the Senate, and one very partisan bill has actually passed the House, that would overturn the IRS’s position and permit the deduction of the expenses paid with the proceeds from a forgiven PPP loan.

Unfortunately for those businesses that participated in the PPP – not to mention the millions of other taxpayers who have been waiting patiently for badly-needed healthcare and economic assistance – this proposed legislation has been held hostage, along with the House and Senate economic stimulus bills that are on the table, by certain politicians who would prefer to exercise their egos rather than get a deal done.

With that said, here we are, November 30, 2020.

Last week, lawmakers in D.C. indicated that the House and Senate Appropriations Committees had reached an agreement on a spending bill to keep the federal government open after its current funding runs out in a couple of weeks.[xxv] There was even talk that some pandemic-related measures may be included the final bill.

Query whether this lame duck Congress is capable of adding a provision – even one that has already received bipartisan support – to ensure the deductibility of expenses properly paid with the proceeds of a forgiven PPP loan?

I hope so. The businesses that participated in the PPP need at least that certainty.

[i] ‘‘Coronavirus Aid, Relief, and Economic Security Act’’ or “CARES Act.” P.L. 116-93.

[ii] The “PPP.” Sec. 1101 et seq. of P.L. 116-93.

[iii] March 27, and April 30, 2020, respectively.

[iv] The first PPP loans were made on April 3 – only one week after enactment of the Program.

The Program was part of the CARES Act, which passed the Senate on March 25, 2020, with an amendment, by a vote of 96 to 0; on March 27, 2020, the House agreed to the Senate amendment by voice vote, and the President signed the legislation that same day.

The Program offered many small businesses the cash liquidity they needed to retain much of their workforce at salaries that approached pre-shutdown levels. It also provided these businesses the wherewithal to pay their rent and utilities, as well as certain other pre-existing indebtedness. The Federal government, working through private lenders, made the funds available to an eligible business through a nonrecourse, unsecured, 100 percent government-guaranteed loan.

[v] The Notice was officially released in 2020-21 IRB 837 (May 18, 2020).

[vi] For example, the rent obligations, utility payments, and payroll costs identified in the CARES Act.

The Code generally provides a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. IRC Sec. 162.

[vii] As described above, the CARES Act did not address the payment of the foregoing expenses by the business. Moreover, neither the Senate nor the House has a contemporaneous legislative history regarding the CARES Act, such as a committee report or technical explanation, which sheds light on these tax issues; although the Joint Committee on Taxation prepared a helpful summary of the legislation’s tax provisions, it did nothing more than repeat the language of the forgiveness provision.


[ix] Health and Economic Recovery Omnibus Emergency Solutions (“HEROES”) Act, H.R. 6800.

[x] In July, the Senate introduced the HEALS Act, which inexplicably failed to address the Notice.

[xi] Unfortunately, these proposals were held hostage to the “piecemeal” vs “all-or-nothing” stimulus package debate that stupidly consumed the leadership on both sides of the political aisle.

[xii] H.R. 925.

[xiii] Absent the application of certain exceptions under IRC Sec. 108 of the Code.

[xiv] Keep reading.

[xv] See, e.g., Bloomberg’s November 11, 2020 Daily Tax Report, “IRS Official Says Stay Tuned for Loan Forgiveness Guidance.”

[xvi] I.e., those businesses that qualified to receive the loans in the first place, that used the proceeds for the prescribed purposes, and that subsequently were able to confirm their qualified status by successfully applying for and receiving forgiveness of their loans.

[xvii] The IRS issued Rev. Proc. 2020-51, which provides a “safe harbor” allowing a taxpayer to claim a deduction in 2020 for certain otherwise deductible PPP eligible expenses if (1) the expenses are paid during the taxpayer’s 2020 taxable year, (2) the taxpayer has a PPP loan which, at the end of the taxpayer’s 2020 taxable year, the taxpayer expects to be forgiven in a later taxable year, and (3) in that later taxable year, the taxpayer’s request for forgiveness of the PPP loan is denied, or the taxpayer decides not to request forgiveness of the PPP loan.

[xviii] What does that even mean? “Reasonable expectation?” Talk about introducing a subjective standard.

[xix] See, for example, former IRC Sec. 118 and Sec. 362. The former provided for the exclusion from gross income of a governmental grant to a business for purposes of constructing certain assets, the cost of which had to be capitalized by the business, while the latter reduced the adjusted basis of the assets in the hands of the business so as to avoid a “double benefit.”

See also the deduction under IRC Sec. 165 for certain losses, provided they are not compensated for by insurance or otherwise; there is an actual economic loss.

[xx] For example, the so-called “insolvency exception” applies. IRC Sec. 108(a).

[xxi] IRC Sec. 108(b)(4)(A).

[xxii] The taxpayer does not lose their deductions claimed for expenses paid with the loan proceeds in earlier years.

[xxiii] See, for example, IRC Sec. 118 before the Tax Cuts and Jobs Act.

[xxiv] See the section labeled “An Alternative.”

[xxv] You can’t make this up, right?