On November 18, 2020, the United States Department of Treasury and Internal Revenue Service (“IRS”) released much anticipated guidance concerning the tax treatment of certain expenses incurred in respect of loans obtained in connection with the Paycheck Protection Program (“PPP Loans”). For a discussion of PPP Loans, please refer to our COVID-19 Resources.
With respect to tax issues pertaining to the forgiveness of PPP Loans, the IRS previously issued Notice 2020-32 (the “Notice”) in which it noted certain expenses would not be deductible, but left many unanswered questions. We previously discussed the Notice here.
In the newly issued guidance, the IRS answered some of those unanswered questions. That guidance takes the form of a Revenue Ruling and a Revenue Procedure.
Revenue Ruling 2020-27
In Revenue Ruling 2020-27, the IRS described two factual hypotheticals. In the first hypothetical, the taxpayer paid for otherwise deductible expenses—e.g., payroll costs, interest on a qualifying mortgage, utilities, and rents (collectively, “Eligible Expenses”)—and had obtained a PPP Loan. As of November 2020, that taxpayer had applied for PPP Loan forgiveness; however, the lender had yet to respond by the end of 2020.
In the second hypothetical, the taxpayer also had incurred Eligible Expenses but had yet to apply for PPP Loan forgiveness as of yearend 2020. That taxpayer otherwise satisfied all of the other requirements for PPP Loan forgiveness.
After describing its earlier guidance (the Notice), the IRS notes this is an area covered by the “tax benefit rule.” That rule provides a taxpayer must take into income an amount equal to a deduction taken in an earlier return if an event occurs that is fundamentally inconsistent with the basis on which the prior deduction was taken. With that analysis in mind, the IRS returned to the two hypotheticals described above.
The IRS ruled that in both instances, the taxpayers are not permitted to claim deductions for the Eligible Expenses on their 2020 income tax returns. This Revenue Ruling is important because it puts to rest questions about how to handle the deductibility of Eligible Expenses for the 2020 tax year, at least as to the two factually specific hypotheticals set forth in the Revenue Ruling. To the extent other questions remains—for example, how to handle the deductibility of Eligible Expenses in the event a lender denies forgiveness of a PPP Loan—the IRS provided additional guidance in the form of a Revenue Procedure.
Revenue Procedure 2020-51
Whereas the Revenue Ruling denied the deductibility of certain amounts, Revenue Procedure 2020-51 provides a safe harbor permitting taxpayers to claim a deduction for those amounts if (1) the Eligible Expenses are paid or incurred in the taxpayer’s 2020 tax year; (2) the taxpayer obtains a PPP Loan the taxpayer expects to be forgiven; and (3) 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.
Subject to a limitation and filing requirement (each described below), a taxpayer satisfying the safe harbor is permitted to deduct otherwise nondeductible expenses (1) on the taxpayer’s timely filed, including extensions, original 2020 return or amended return; or (2) 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 2020-51 Statement” that must include:
(1) The taxpayer’s name, address, and Social Security Number or Employer Identification Number;
(2) A statement specifying the grounds for eligibility;
(3) A statement for which year of deduction the taxpayer is seeking;
(4) The amount and date of disbursement of the taxpayer’s PPP Loan;
(5) The total amount of PPP Loan forgiveness the taxpayer was denied or will never seek;
(6) The date on which the taxpayer was denied or decided to never seek forgiveness; and
(7) The total amount of Eligible Expenses and nondeductible Eligible Expenses that are reported on the taxpayer’s return.
In issuing Revenue Ruling 2020-27 and Revenue Procedure 2020-51, the IRS answered a number of questions related to when taxpayers are not permitted to claim otherwise deductible expenses based on the existence of a PPP Loan, as well as how and when to claim those deductions if PPP Loan forgiveness is denied or if the taxpayer irrevocably decides not to seek PPP Loan forgiveness.