IRS provides further guidance regarding deductibility of business expenses paid with PPP loan funds

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After the Paycheck Protection Program (PPP) was passed in March of 2020, the IRS issued Notice 2020-32 on April 30 and took the position that no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of a PPP covered loan. Therefore, the IRS’s position denies deductions for certain expenses paid with PPP loan proceeds that are ultimately forgiven. For a previous discussion of this notice, click here.

The IRS recently issued additional guidance clarifying its position relating to deducting expenses paid or incurred with PPP loan proceeds. In Revenue Ruling 2020-27, the IRS stated that a taxpayer who received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act (“eligible expenses”) may not deduct those expenses in 2020 if, at the end of 2020, the taxpayer reasonably expects to receive forgiveness of the covered loan, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of 2020. This ruling applies if: (i) the taxpayer has applied for PPP loan forgiveness but the lender has not responded by the end of 2020, or (ii) the taxpayer has incurred eligible expenses, has a reasonable expectation of reimbursement in the form of forgiveness, and expects to apply for forgiveness in 2021 but has yet to apply for PPP loan forgiveness by 2020 year end. Therefore, no deductions for the eligible expenses are allowed on the 2020 income tax return.

Safe harbor

In conjunction with the Revenue Ruling, the IRS also issued a corresponding Revenue Procedure 2020-51 that provides a safe harbor allowing taxpayers to claim a deduction for eligible expenses if certain criteria are met. A taxpayer meets the safe harbor requirements if: (i) the taxpayer paid or incurred eligible expenses in the 2020 tax year; (ii) the taxpayer either applied for covered loan forgiveness to the lender before the end of 2020 or intends to apply for loan forgiveness in the subsequent year; and (iii) the lender denies the request for loan forgiveness or the taxpayer decides not to seek forgiveness for some or all of the PPP loan in 2021.

A taxpayer is not allowed to use the safe harbor procedures in Revenue Procedure 2020-51 unless the taxpayer attaches a statement to the return titled “Revenue Procedure 2020-51 Statement” and must include: (1) taxpayer’s name, address, and social security number or employer identification number; (2) a statement specifying how the taxpayer is an eligible taxpayer under the safe harbor provisions of Revenue Procedure 2020-51; (3) a statement describing whether the taxpayer is claiming the deduction in tax year 2020 or 2021 pursuant to section 4.01 or section 4.02 of Revenue Procedure 2020-51; (4) the amount and date of disbursement of the taxpayer’s covered loan; (5) the total amount of covered loan forgiveness that the taxpayer was denied or decided to no longer seek; (6) the date the taxpayer was denied or decided to no longer seek covered loan forgiveness; and (7) the total amount of eligible expenses and non-deducted eligible expenses that are reported on the return.

A taxpayer taking advantage of the safe harbor procedures may be able to deduct some or all of the eligible expenses on (i) the taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for the 2020 tax year; (ii) an amended return or an administrative adjustment request under section 6227 of the Internal Revenue Code for 2020; or (iii) the taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for the 2021 tax year.

Is this the last word?

While this latest IRS guidance was issued to confirm and clarify its original stance, some congressional members continue to express disapproval of the IRS’s position as contrary to legislative intent under the CARES Act. Legislative remedial action is being considered to correct the IRS’s position and conform it to legislative intent. Thus, this is unlikely to be the final development on this topic.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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