Originally published on Forbes.com.

One of the key parts of the CARES Act was the Paycheck Protection Program. It proved so popular that additional funds were appropriated for it. The essence of PPP is that a business borrows from the SBA based on 2.5 months of last year’s payroll. If it spends the money within eight weeks on payroll and certain other expenses such as rent, the loan is forgiven. Of course, it is somewhat more complicated than that, but that is the essence.

Normally when a loan is forgiven, it results in income to the taxpayer. The CARES Act indicates that is explicitly not the case with the forgiveness of a PPP loan. This gave PPP an extra attraction compared to letting employees collect unemployment, possibly supplementing that with relief payments deductible under Section 139 that would not be taxable to the employees.

A Potential Problem

Some sharp minds saw a fly in that ointment. On April 17, I wrote about Greg Burnhardt who posted on #TaxTwitter that Code Section 265 might deny the deduction. Code Section 265 denies a deduction for otherwise allowable expenses that are allocable to exempt income. I figured that if Greg was right, that inserting the exclusion in the CARES Act was kind of pointless.

An Actual Problem

Well, I guess it was pointless, because the IRS has ruled in Notice 2020-32, that Greg was right. Of course, that is not how they put it.

“Specifically, this notice clarifies that no deduction is allowed under the Internal Revenue Code (Code) 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 Coronavirus Aid, Relief, and Economic Security Act (CARES Act)”

That probably kills the major incentive to use PPP over unemployment if you really have nothing for people to do. There is the matter of what your future unemployment rate might be, but modelling that is very challenging.

Some Will Fight It

PPP can still be a really good deal and I think it would be worth testing the IRS on this. I am close to certain that more than a few taxpayers will take the deduction anyway and the matter will end up in the courts unless Congress quickly clarifies this one way or the other.