On November 18, 2020, the U.S. Treasury Department and IRS released further guidelines on the tax treatment of expenses paid with funds from PPP loans. After IRS Notice 2020-32 (released in April 2020) provided that no deduction would be allowed for expenses paid with proceeds from forgiven loans, this week’s release of Revenue Ruling 2020-27 and Revenue Procedure 2020-51 further clarified the tax treatment and non-deductibility of expenses paid with PPP proceeds.
Revenue Ruling 2020-27 provides that expenses paid with funds from PPP loans will not be deductible if at the time of filing the return for the year in which the expenses would ordinarily be deducted, forgiveness of the loan was “reasonably expected to occur.” Thus, if a taxpayer reasonably expects that their PPP loan will be forgiven, the expenses that were paid with the PPP loan proceeds would not be deductible on the taxpayer’s 2020 tax returns.
Nonetheless, Revenue Procedure 2020-51 provides a safe harbor that allows for taxpayers to claim a deduction if:
- The eligible expenses are paid or incurred during the taxpayer’s 2020 taxable year;
- The taxpayer received a PPP loan, and at the end of the year, the taxpayer expects the loan to be forgiven in a taxable year after 2020; and
- In a subsequent taxable year, the taxpayer’s request for forgiveness of the covered loan is denied, in whole or in part, or the taxpayer decides never to request forgiveness of the covered loan.
Therefore, should a taxpayer’s request for PPP forgiveness be denied, in whole or in part, in 2021, that taxpayer will have the ability to deduct those related expenses stemming from the funds received from the PPP loan in either their 2020 or 2021 tax returns.
Despite the IRS position that permitting both tax-free forgiveness of the PPP loan and deductions would be a double benefit, there is still a possibility that Congress may pass legislation to allow for the deductibility of expenses that were paid with funds from PPP loans. The Small Business Expense Protection Act, S.3612, was one such bill. It was introduced into the Senate Committee on Finance in May 2020 but has not been acted upon. In addition, the House introduced a similar piece of legislation, the HEROES Act, in May 2020 which provides that “notwithstanding any other provision of law, any deduction and the basis of any property shall be determined without regard to whether any amount is excluded from gross income.” However, like its counterpart in the Senate, the HEROES Act has remained in Committee. With all the turmoil currently in Washington, it is not likely that any further legislative fixes will occur this year.
Closer to home, it is the position of the Pennsylvania Department of Revenue that forgiven PPP loans will be treated as taxable income for Pennsylvania personal income tax purposes. This allows for businesses to deduct ordinary, necessary, and reasonable business expenses related to income derived from those loans. Should the borrower be a corporation that is subject to the Pennsylvania corporate net income tax, Pennsylvania law does not provide for an add back to, or deduction from, federal taxable income for any subsequent forgiveness of a PPP loan. As such, while Pennsylvania would not impose corporate level tax on the amount of the forgiveness, since Pennsylvania follows the federal treatment, the expenses that were paid with the proceeds from the loan would likewise not be deductible for Pennsylvania corporate net income tax purposes.