On Wednesday, November 18th, the Internal Revenue Service (IRS) clarified that expenses paid by PPP loan proceeds, even if the loan has not been forgiven in 2020, does not entitle the taxpayer to a deduction for those expenses.
IRS Revenue Ruling 2020-27 took the position, in which practitioners and loan recipients were dreading, that expenses covered by PPP funds would not be deductible if loan forgiveness is “reasonably expected to occur”, even if forgiveness is granted subsequent to close of the 2020 tax year.
The PPP loan program was created by the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136), written into law in March, and provides loans to businesses and sole proprietors that can be forgiven on a tax-free basis if portions of the proceeds are spent on items such as payroll, utilities, rent, etc.
The Small Business Administration (SBA) and Department of the Treasury were inundated with questions after the roll-out of this program. One of the most critical unanswered questions, until now, was how expenses paid with loan proceeds would be treated by the taxpayer on their Federal income tax return. The IRS in response, issued Notice 2020-32, 2020-21 IRB 837 which stated that these expenses, if forgiveness occurred, would not be deductible to avoid a double-tax benefit by the recipient.
To add relevant examples, the IRS laid out two scenarios in Rev. Rul. 2020-27. In these scenarios, both borrowers pay expenses such as payroll and mortgage interest that qualify under the CARES Act as valid PPP expenditures and satisfy all requirements under the CARES Act to have their loans forgiven. However, one borrower applies for forgiveness in November 2020 and doesn’t yet have an answer as to whether it will be forgiven, while the other borrower expects to apply for forgiveness in 2021.
According to the IRS, both businesses cannot deduct expenses funded with PPP loans because they have a reasonable expectation of forgiveness.
“A taxpayer that received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year,” the government concluded.
To address the possibility that some PPP loans will not be forgiven in full, but the taxpayer may have included all qualifying expenses as nondeductible on their 2020 return, the IRS issued Rev. Proc. 2020-51, which provides a safe harbor for PPP borrowers whose loan forgiveness has been partially or fully denied and wish to claim those deductions not covered by non-forgiven loan proceeds on a return, amended return, or administrative adjustment request.
If you have any questions on these new clarifications, we can help. Please contact our team or your Mueller Prost advisor directly.