The IRS has issued new guidance related to the accounting for PPP loans in Notice 2020-32. The IRS’ position is that while loan forgiveness is excluded from gross income, the expenses that resulted in qualification for forgiveness are not deductible. While this position does not change the net result, it can significantly complicate the accounting.
Following is an excerpt from the notice:
“Under the Paycheck Protection Program, a recipient of a covered loan may use the proceeds to pay (1) payroll costs, (2) certain employee benefits relating to healthcare, (3) interest on mortgage obligations, (4) rent, (5) utilities, and (6) interest on any other existing debt obligations.
“[A] recipient of a covered loan can receive forgiveness of indebtedness on the loan (covered loan forgiveness) in an amount equal to the sum of payments made for the [specified] expenses during the 8-week “covered period” beginning on the covered loan’s origination date. . . . [T]he amount of the covered loan forgiveness is reduced if, during the covered period, (1) the average number of full-time equivalent employees of the recipient is reduced as compared to the number of full-time employees in a specified base period, or (2) the salary or wages of certain employees is reduced by more than 25 percent as compared to the last full quarter before the covered period. In addition, pursuant to an interim final rule issued by the Small Business Administration, no more than 25 percent of the amount forgiven can be attributable to non-payroll costs.”
The notice goes on to state that no deduction is allowed for expenses that are allocable to a class of income that is exempt from taxes. In the case, while the debt relief is not includible in income, the expenses supporting it are not deductible. Under the notice, the debt relief is treated as tax-exempt income. Per IRC § 265, expenses that are incurred to generate tax-exempt income are not deductible.
This result is reasonable, but potentially difficult to account for. Due to the complexity of most companies’ books, S&W recommends creating a separate general ledger account for the debt relief (assuming a company has been granted debt relief under the PPP program). However, income tax returns will reflect this amount as a contra-expense rather than an item of income. This accounting treatment may evolve as more guidance is issued.
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