After months of uncertainty, there is now clear congressional and IRS guidance regarding the deductibility of business expenses for small businesses that have portions of a covered loan forgiven pursuant to the Paycheck Protection Program of the CARES Act. Legislation signed into law on December 27, 2020 reverses prior IRS guidance and specifically allows deductions for otherwise deductible expenses paid with PPP funds, even if the PPP loan is subsequently forgiven.
The CARES Act was explicit on some specific tax consequences but was silent as to whether a deduction would be allowed for certain business expenses paid with PPP funds that are ultimately forgiven, given the fact that no income would be reported in conjunction with the PPP loan forgiveness. So the question remained: Did Congress intend to provide small businesses a double tax benefit when it passed the Paycheck Protection Program, or was the CARES Act’s lack of clear, specific language on the topic of business expense deductibility just an oversight?
In an effort to provide clarity where the law was silent, the IRS subsequently issued three notices – Notice 2032-32 in April 2020 (discussed here) and Revenue Ruling 2020-27 and Revenue Procedure 2020-51 in November 2020 (discussed here) – that collectively took the position that, based on fundamental tax principles, the double-dipping of tax deductions would be prohibited.
Congress specifically allows double tax benefit
Congress subsequently passed the COVID-related Tax Relief Act of 2020 as part of the Consolidated Appropriations Act, 2021 (CAA) that was signed into law on December 27, 2020, overturning previous IRS guidance, clarifying the matters related to this ongoing uncertainty, and providing additional relief to taxpayers amid the ongoing COVID-19 pandemic. Congress expressly confirmed there is no income inclusion by reason of the forgiveness of a PPP loan and further clarified that deductions will not be disallowed because the expenses were paid with covered loan proceeds that were subsequently forgiven and excluded from income. Specifically, Section 276 of the Tax Relief Act expressly provides that “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income.”
To conform with the newly enacted provisions of the CAA, the IRS issued Revenue Ruling 2021-2 on January 6, 2020. This new ruling expressly overturned its prior position and confirmed that amounts spent on otherwise deductible expenses will still be deductible in the event of forgiveness of a PPP loan under the CARES Act.
Next steps for taxpayers
The provisions regarding the deductibility of expenses are retroactive and apply to any taxable year ending after the enactment of the CARES Act. Because the actual implications of these provisions may vary by taxpayer, PPP loan recipients should consult with a tax professional for advice specific to their circumstances.