Discharge of debt is often normally treated as taxable income under the U.S. tax code, but sometimes exceptions are made, as the CARES Act did. Because of this exception, the IRS has invoked a provision in the tax code, Section 265(a)(1), that calls for disallowing a deduction for expenses directly related to a class of income that is wholly exempt from income tax. The rationale in the code is to prevent a double tax benefit. The IRS pointed out in the notice that the CARES Act excludes loan forgiveness from taxable income, and that the Act did not make an exception for the disallowance rule in Section 265(a)(1).
We believe the intent of Congress was to provide tax relief by making the forgiveness of PPP debt non-taxable. The disallowance of underlying expenses essentially neutralizes the tax relief aspect of this intent and may have been an unforeseen consequence. Given the hasty nature of the passage of the CARES Act, an oversight such as this is not surprising. Regardless, it is important in your current tax planning strategies to assume the qualified expenses underlying PPP loan forgiveness are not tax-deductible until further guidance is provided.
We will monitor the situation closely to see if Congress steps in or if the IRS changes their position and restores the deductibility of the expenses. So stay tuned and stay well!
