Deductible Expenses and the Paycheck Protection Program

On April 30, 2020, the Internal Revenue Service (IRS) released Notice 2020-32. The notice provided guidance on otherwise deductible business expenses covered with the Small Business Administration’s Paycheck Protection Program (PPP) loan proceeds that are either partially or completely forgiven and excluded from the taxpayer’s income. The IRS, relying on Internal Revenue Code (IRC) Section 265(a), concluded that deductible expenses covered by PPP funding that has been forgiven, cannot be deducted on your federal income taxes.

Section 1106(b) of the CARES Act permits PPP borrowers to request forgiveness of indebtedness in an amount equal to the sum of payments for eligible expenses (payroll, rent, mortgages, utilities, etc.) during the eight-week covered period which begins on the PPP loan date. The CARES Act notes that this forgiven amount must be excluded from the borrower’s taxable income. However, the IRS determined that the CARES Act income exclusion for forgiven PPP loan amounts creates a “class of exempt income” and is not permitted under IRC Section 265(a)(1).

Treasury FAQ

On May 6, 2020, the Treasury issued a PPP Frequently Asked Questions (FAQs). Amongst other things, the FAQ stated that the exclusion of any employee compensation in excess of an annual salary of $100,000 does not apply to all employee benefits and applies only to cash compensation, not to non-cash benefits, such as:

employer contributions to defined-benefit or defined-contribution retirement plans;
payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums; and
payment of state and local taxes assessed on the compensation of employees.

The FAQ also provided more details to borrowers on how to calculate their aggregate payroll cost. Borrowers can make this determination by using data either from the previous 12 months or from the calendar year 2019, the FAQ details. For seasonal businesses, the borrower may use average monthly payroll for the period between February 15, 2019, or March 1, 2019, and June 30, 2019. For the purposes of applying an employee-based size standard, borrowers may use their average employment over the same time periods to determine their number of employees. In the alternative, borrowers may use the SBA’s usual calculation (the average number of employees per pay period in the 12 completed calendar months prior to the date of the loan application [or the average number of employees for each of the pay periods that the business has been operational if it has not been operational for 12 months].

Additional FAQ key takeaways:

Any amounts that a borrower has paid to an independent contractor or sole proprietor should be excluded from payroll costs.
Payroll costs are calculated on a gross basis without regard to federal taxes imposed or withheld and income taxes required to be withheld from employees.
The SBA and Treasury intend to issue an interim final rule excluding laid-off employees whom the borrower offered to rehire (for the same salary/wages and the same number of hours) from the CARES Act’s loan forgiveness reduction calculation. To qualify for this exception, the borrower must have made a good faith, written offer of rehire, and the employee’s rejection of that offer must be documented by the borrower.

We are continuing to closely monitor the CARES Act and will update you with any additional changes or modifications. If you have questions about the CARES Act, one of our attorneys can assist you. Please do not hesitate to contact the Wladis Law Firm if you have any questions about the above information. We will do our best to provide you with updates and will be available to answer questions as circumstances change. We may be reached at (315) 445-1700 or by e-mailing Attorney Jennifer Huse Granzow at jgranzow@wladislawfirm.com or by reaching out to your everyday firm contacts.