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IRS Says No Deduction for Expenses Generating Loan Forgiveness

Late yesterday the IRS issued Notice 2020-32 clarifying that no deduction is allowed for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the CARES Act. Sen. Chuck Grassley, the chairman of the Finance Committee, said Thursday that he was disappointed in the IRS decision. “The intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible…this Notice is contrary to that intent.” This is evident in the law’s provision to exclude the amount forgiven from taxable income. For example, if the amounts were taxable, and the expenses deductible, taxpayers would be in the same place. Said another way, why exclude the forgiven amount from income at all just to deny the deductions and put taxpayers in the income position? Section 1106(i) of the CARES Act addresses certain Federal income tax consequences resulting from covered loan forgiveness. Specifically, that subsection provides that, for purposes of the Code, any amount that would be includible in gross income of the recipient by reason of forgiveness described in section 1106(b) “shall be excluded from gross income.” Section 1106(i) of the CARES Act operates to exclude from the gross income of a recipient any category of income that may arise from covered loan forgiveness. Neither section 1106(i) of the CARES Act nor any other provision of the CARES Act addresses whether deductions otherwise allowable under the Code for payments of eligible section 1106 expenses by a recipient of a covered loan are allowed if the covered loan is subsequently forgiven under section 1106(b) of the CARES Act as a result of the payment of those expenses. In its decision the IRS Notice points to section 265(a)(1) of the Internal Revenue Code which provides that no deduction is allowed to a taxpayer for any amount otherwise allowable as a deduction if it is allocable to tax exempt income. Loan forgiveness results in tax exempt income, therefore §265(a)(1) disallows the deduction of expenses generating forgiveness. Congress could pass a law allowing the deductions and overriding the IRS ruling, but for now, the expenses will not be deductible. If you have any questions regarding the Notice 2020-32, please consult your HBK tax advisor. We are standing by and ready to help.

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About the Author(s)
Ben is a Principal in the Tax Advisory Group (TAG) of HBK and works in the Youngstown, OH office. He has been with the firm since 2009 and has focused extensively on entity tax issues, entity planning, and flow-through taxation. Additionally, he has experience with many of our real estate and manufacturing clients. As a member of TAG, Ben frequently teaches tax-related training courses both internally for the firm and externally for clients and the public. Ben provides research and expert counsel on complex tax issues for our clients. He also regularly appeared on the mid-day news broadcast of Youngstown, Ohio's NBC affiliate station in a segment called “Smart Money,” which highlights personal financial planning tips.
Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.