Article written by:
Kaz Unalan, CPA, CEPA
Director, Tax & Business Advisory Services
Chris Dean, CPA
Director, Tax & Business Advisory Services
On November 18, 2020, the Treasury and the IRS released much anticipated guidance on the tax treatment and timing of certain expenses incurred related to loans obtained in connection with the Paycheck Protection Program (PPP) that was part of the CARES Act signed into law on March 27, 2020. While the CARES Act excluded the forgiveness of such loans from taxable income, there were no provisions that addressed the deductibility of expenses paid with the loan proceeds.
The IRS previously issued Notice 2020-32, which concluded that taxpayers may not claim a deduction for otherwise deductible business expenses that were generated by the use of PPP loan proceeds in respect of forgiven PPP loans. The basis for this conclusion is related to long-standing tax law and precedents related to expenses allocable to classes of tax-exempt income and the treatment of reimbursed expenses.
Since the issuance of that guidance, taxpayers have been left with a degree of uncertainty as to the recognition timing of such nondeductible expenses. Specifically, how the timing of filing forgiveness applications, and ultimately having loans approved or denied for forgiveness, would impact expenses paid or incurred in 2020. Rev. Rul. 2020-27 clarified these timing issues and affirmed the IRS’s position that expenses related to the use of PPP loan proceeds are nondeductible.
In Rev. Rul. 2020-27, the IRS gave two hypothetical examples of taxpayers filing their loan forgiveness applications. In both examples the taxpayers are on a 2020 calendar year end.
In the first hypothetical example, the taxpayer paid for otherwise deductible expenses (payroll costs, interest on a qualifying mortgage, utilities, and rents) and had obtained a PPP Loan. As of November 2020, that taxpayer had applied for PPP loan forgiveness; however, the lender had yet to approve or deny the application by the end of 2020.
In the second hypothetical example, the taxpayer also had incurred eligible PPP loan expenses, however had not yet applied for PPP loan forgiveness as of the end of 2020. That taxpayer otherwise satisfied all of the other requirements for PPP loan forgiveness.
In both examples, the IRS ruled that if the taxpayer “reasonably expects” to receive forgiveness on these otherwise deductible expenses, those expenses are nondeductible on their 2020 income tax returns. Those examples affirm the position of the IRS that the timing of the forgiveness does not ultimately delay the expenses from being nondeductible in 2020.
In addition to Rev. Rul. 2020-27, the IRS issued Rev. Proc. 2020-51 to address how to handle situations where the lender denies all or part of PPP loan forgiveness. Under Rev. Proc. 2020-51, a safe harbor is established to allow taxpayers to claim a deduction for those expenses if:
- The eligible expenses are paid or incurred in the taxpayer’s 2020 tax year;
- The taxpayer obtains a PPP loan the taxpayer expects to be forgiven; and
- In a subsequent tax year, (i) the lender denies the taxpayer’s request for forgiveness, or (ii) the taxpayer irrevocably decides never to request forgiveness of the taxpayer’s PPP loan.
A taxpayer satisfying the safe harbor is permitted to deduct otherwise nondeductible expenses:
- On the taxpayer’s timely filed original 2020 return or amended return, including extensions original 2020 return or amended return; or
- On a tax return for a subsequent tax year.
A taxpayer seeking this relief is not permitted to deduct an amount of otherwise nondeductible expenses in excess of the principal amount of the taxpayer’s PPP loan for which forgiveness was denied or will never be sought.
In order to claim a deduction, the taxpayer is required to attach to the taxpayer’s return a statement titled “Revenue Procedure 2021-51 Statement” that must include specified information related to the grounds for eligibility, year of deduction and certain PPP loan and expenses information.
This latest guidance answered and further affirmed a number of questions as it relates to the tax treatment and timing of PPP loan forgiveness and related eligible expenses. As 2020 comes to an end, taxpayers should be using this time to fully understand the implications of PPP loan forgiveness and to plan accordingly.