Businesses that reasonably anticipate that loans under the Paycheck Protection Program will be forgiven should be aware that they cannot claim a deduction for the eligible expenses paid or incurred during the 2020 taxable year.
However, to the extent that a PPP loan is ultimately not forgiven – or the taxpayer irrevocably revokes a request for loan forgiveness – that taxpayer may be eligible to avail itself of the safe harbor and deduct eligible expenses that it would not otherwise have been able to deduct.
These are the key takeaways from a pair of guidance documents recently issued by the IRS – Rev. Rul. 2020-27 and Rev. Proc. 2020-51 – that clarify the deductibility of certain expenses related to PPP loans.
Under Section 1106(b) of the Coronavirus Aid, Relief and Economic Security (CARES) Act, an individual or entity eligible to receive a PPP loan can receive forgiveness of the full principal amount of the loan up to an amount equal to the following eligible expenses:
- payroll costs
- interest on a covered mortgage obligation
- any covered rent obligation payment
- any covered utility payment
CARES Act Section 1106(i) provides that any amount of a PPP loan that would be includible in gross income of a taxpayer due to forgiveness of the loan shall be excluded from gross income.
In May 2020, the IRS released Notice 2020-32, which provided that no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP loan.
The new guidance documents confirm and clarify the IRS’s position regarding deducting eligible expenses if a PPP loan is ultimately forgiven or not.
Rev. Rul. 2020-27
Rev. Rul. 2020-27 confirms that a calendar-year taxpayer who obtained a PPP loan may not deduct eligible expenses that the taxpayer paid or incurred in its 2020 tax year if, at the end of its 2020 tax year, the taxpayer reasonably expects that its PPP loan will be forgiven.
The guidance discusses two scenarios in which calendar-year taxpayers paid expenses that would otherwise be deductible as ordinary and necessary business expenses, including payroll costs, mortgage interest, utility payments, and rent (eligible expenses).
The taxpayer applied for PPP loan forgiveness in November 2020 on the basis of the eligible expenses it paid. At the time of the application, the taxpayer satisfied all requirements under Section 1106 of the CARES Act for forgiveness of the PPP loan, but the taxpayer is not informed by the lender as to whether the PPP loan will be forgiven before the end of 2020.
The taxpayer did not apply for forgiveness of the PPP loan before the end of 2020. However, the taxpayer satisfied all requirements under Section 1106 of the CARES Act for forgiveness of the PPP loan. The taxpayer expects to apply to the lender for forgiveness of the PPP loan in 2021.
In both situations, the taxpayers reasonably expect reimbursement of the eligible expenses through PPP loan forgiveness. The IRS concluded that the taxpayers in both scenarios would not be permitted a deduction for the expenses that the taxpayers paid to the extent that the payment of the eligible expenses are allocable to tax-exempt income in the form of the reasonably expected PPP loan forgiveness.
The IRS relied on Section 265(a)(1) of the Internal Revenue Code which disallows a deduction for eligible expense otherwise allowable as a deduction to the extent that the payment of the eligible expense is allocable to tax-exempt income in the form of PPP loan forgiveness.
Rev. Proc. 2020-51
Rev. Proc. 2020-51 provides a safe harbor allowing a taxpayer that receives a PPP loan to deduct eligible expenses paid or incurred during the taxpayer’s 2020 taxable year if, at the end of the 2020 taxable year, the taxpayer expects that the PPP loan will be forgiven and in a subsequent taxable year, the request for forgiveness is denied, in whole or in part, or the taxpayer decides not to request forgiveness of the PPP loan.
A taxpayer may be able to deduct some or all of the eligible expense on its timely filed, including extensions, original income tax return or information return for the 2020 taxable year, an amended return for the 2020 taxable year, or the taxpayer’s timely filed, including extensions, original income tax return or information return for the subsequent taxable year.
A taxpayer is eligible to avail itself of the safe harbor if all three of the following occur:
- the taxpayer paid or incurred eligible expenses in the 2020 taxable year for which no deduction was permitted because at the end of the 2020 taxable year the taxpayer reasonably expected that its PPP loan will be forgiven based on the eligible expenses
- the taxpayer submitted before the end of the 2020 taxable year, or as of the end of the 2020 taxable year intends to submit in a subsequent taxable year, an application for PPP loan forgiveness to the lender
- in a subsequent taxable year, the lender denies PPP loan forgiveness for all or part of the PPP loan, or the taxpayer irrevocably decides not to seek forgives for some or all of the covered loan
To avail itself of the safe harbor, a taxpayer must attach a statement to the tax return on which the taxpayer deducts the eligible expenses. The statement must include the following:
- Taxpayer’s name, address and social security number/employer identification number
- A statement specifying that the taxpayer is eligible to deduct the eligible expenses it paid or incurred in the 2020 taxable year either because the taxpayer requested PPP loan forgiveness and the forgiveness was partially or wholly denied or the taxpayer decides not to seek forgiveness for some or all of the PPP loan
- A statement that the taxpayer is applying the safe harbor in Section 4.01 of the revenue procedure for expenses claimed in 2020 or Section 4.02 for expenses claimed in a subsequent taxable year
- The amount and date of disbursement of the taxpayer’s covered loan
- The total amount of covered loan forgiveness that the taxpayer was denied or decided to no longer seek
- The date the taxpayer was denied or decided to no longer seek covered loan forgiveness
- The total amount of eligible expenses and non-deducted eligible expenses that are reported on the tax return
Businesses that obtained PPP loans and have requested forgiveness from lenders should continue to monitor the status of the loan forgiveness request. To the extent that the lender does not forgive the PPP loan, the business may be eligible to deduct certain eligible expenses that it would not have been eligible to deduct if the PPP loan was forgiven.