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Should Business Expenses Paid by PPP Be Deductible?

Everyone suffered when the coronavirus pandemic hit the entire world. In fact, some are still suffering.

In the U.S., President Donald Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act into law to alleviate the economic burden brought on by the pandemic. One of its provisions is the Paycheck Protection Plan (PPP) addition to the Small Business Act.

What is a PPP?

It is a form of forgivable loan for small businesses. This is necessary so that these businesses could continue paying for the salaries of their employees including health benefits. The PPP could also be used for rent, utilities, mortgage, and interest on other debt.

So, should this loan be subjected to federal income tax? Also, should it be subjected to the Pennsylvania Personal Income Tax and Pennsylvania Corporate Net Income Tax.

CARES Act is silent

The coronavirus-related law doesn’t really explain whether the forgivable loan is taxable. As a rule, payments made are always deductible. Of course, there is always an exception or two to the rules.

On a regular situation, salaries or rent would be tax deductible. These are considered income after all. However, it can be argued that the PPP used to pay salary, rent, etc. is a grant.

To understand the situation, it’s important to go back to 1982. In Monaccio vs. Commissioner, a taxpayer wanted to deduct expenses spent for a course that was actually a grant. The Veterans’ Administration gave the tax-exempt grant through educational assistance.

In that case, the Court ruled that the grant was not deductible based on the Internal Revenue Code (IRC).

To answer the current issue regarding the PPP, the Internal Revenue Service (IRS) issued Notice 2020-32 last May 2. The notice cited Section 265(a) of the IRC, which states: “Where tax-exempt income is used for a specific purpose and expenses are incurred for that purpose, no deduction from adjusted gross income is allowed.”

In essence, the expense payments are not deductible since the taxpayer is actually receiving reimbursement for the costs.

Income tax

The Personal Income Tax doesn’t follow the same route. The last guideline on the matter was the Personal Income Tax Bulletin 2009-04 called the Cancellation of Business Indebtedness. Deductibility and taxability are similar in this matter.

The PIT is essentially different from the taxable income. However, when Notice 2020-32 is put into the equation, the result for the PIT and federal income tax becomes similar.

It has to be noted, though, that this is not similar to how the economic impact payments are treated. The stimulus checks released by the federal government are rebates. Therefore, they are not taxable in Pennsylvania.

The PPP loans under the Corporate Net Income Tax will have the same treatment as noted in the Notice 2020-32. Such is limited to federal income tax purposes.

The COVID-19 effect

Interpretation is necessary to avoid the double-dip effect. The federal and Pennsylvania interpretations are meant to be fair for all persons concerned.

The entire world was affected by the COVID-19 pandemic. Aside from the obvious health problems, the economic difficulty was more pronounced.

This is why Congress passed the CARES Act to aid American taxpayers. However, with every fiscal matter raised, the tax subject follows.

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