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The IRS issued a new ruling and procedural guidance on November 18, 2020, in the form of Revenue Ruling 2020-27 and Revenue Procedure 2020-51, announcing guidance on the tax deductibility of expenses related to the Paycheck Protection Program (PPP) loans that have not yet been forgiven. The new releases provide significant clarity for many taxpayers whose businesses were affected by the COVID-19 pandemic, for whom the deductibility of PPP expenses will be an important issue for their 2020 tax returns. The IRS ruling indicates that taxpayers who paid otherwise deductible expenses with PPP funds may not deduct them on their 2020 tax return if they reasonably expect their PPP loan to be forgiven.
As part of the CARES Act and later the PPP Flexibility Act, the PPP program provided businesses with loans, which were forgivable if they were used for specified business expenses (primarily payroll, along with rent or mortgage expenses and utilities). For financial statement purposes, the expenses paid for by PPP loans may reduce net income in 2020, with an offsetting income inclusion when the loan is forgiven; for tax purposes, the CARES Act specified that the loan’s forgiveness would not create taxable income.
In May, the IRS issued Notice 2020-32, which takes the position that a deduction is not allowed for expenses related to PPP loans if the loan is forgiven. However, that Notice applied only to amounts that had already been forgiven, leaving open the question of what to do with expenses from loans that had not yet been forgiven. When the PPP Flexibility Act, which became law after the IRS issued Notice 2020-32, extended the time to file for forgiveness until late 2021, it became very likely that many taxpayers will not have received a forgiveness determination by the time they file their 2020 tax return.
Reasonable Expectation of Forgiveness
The Revenue Ruling considers two scenarios. In both, a calendar year taxpayer has received a PPP loan and used the proceeds for covered expenses during its covered period. As a result, the taxpayer “reasonably expects to receive forgiveness.” In Scenario 1, the taxpayer has applied for forgiveness before the end of 2020 but did not receive a determination before the end of 2020. In Scenario 2, the taxpayer did not apply for forgiveness before the end of 2020 but waited until 2021.
In both scenarios, the IRS indicates that the PPP loan expenses should not be deducted on the taxpayer’s 2020 tax return. The deciding factor in both scenarios is that the taxpayer reasonably expects to receive forgiveness. This eliminates the potential to protect the deductibility of these expenses in the 2020 taxable income calculation by merely delaying the application for forgiveness until 2021.
Revenue Procedure 2020-51 provides a safe harbor for taxpayers to later deduct expenses related to a PPP loan if they reasonably expected forgiveness but later have their forgiveness application denied in whole or in part, or decide not to seek forgiveness. The expenses can either be deducted on an amended 2020 return or on a return relating to the subsequent tax year when it becomes clear that the taxpayer will not receive forgiveness (likely either 2021 or 2022).
If taxpayers are concerned about the effect of the non-deductible of these expenses in computing their 2020 taxable income, they should conduct an analysis now to determine whether they qualify for forgiveness. If they reasonably expect forgiveness, and the removal of those expenses will create additional taxable income in 2020 (or a significant increase in income), additional year-end planning should be considered, including deferral of income or acceleration of expenses.
Our team is happy to analyze whether you can reasonably expect to receive PPP loan forgiveness and can help you with additional planning if necessary.
If you have questions on the information outlined above or need assistance with transactional tax planning, JLK Rosenberger can help. For additional information, call us at 949-860-9895 or click here to contact us. We look forward to speaking with you soon.