Last week, the Internal Revenue Service (IRS) issued additional guidance on two outstanding issues regarding Paycheck Protection Program (PPP) Loans and the Employee Retention Tax Credit (ERTC) provisions of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). First, the IRS updated previously published Frequently Asked Questions (FAQs) to provide helpful clarification of the interaction of the ERTC and PPP Loans in M&A transactions.1 Second, the IRS issued Revenue Ruling 2020-27 (Revenue Ruling) and Revenue Procedure 2020-51 (Revenue Procedure), which address the deductibility of PPP Loan expenditures made in a taxable year if the PPP Loan has not been forgiven by the end of such taxable year.
Interaction of the ERTC and PPP Loans in M&A Transactions
The CARES Act and previously published FAQ 81 provide that a borrower of a PPP Loan may not also take the ERTC. This has raised questions in M&A transactions regarding whether a buyer of stock or assets of a target risks jeopardizing the buyer's ERTC (including the ERTC taken by employers aggregated with the buyer for purposes of these rules (buyer group)) if the target has a PPP Loan outstanding as of the date of the closing of the transaction (closing date).
In FAQ 81a, the IRS addressed situations in which a buyer that has taken or intends to take the ERTC acquires the stock of a target that has a PPP Loan outstanding. FAQ 81a provides that if, prior to the closing date, the target either (i) fully satisfies the PPP Loan in accordance with paragraph 1 of the Small Business Administration Notice effective October 2, 2020 (the SBA October 2 Notice) or (ii) submits a forgiveness application to the lender and establishes an interest-bearing escrow account in accordance with paragraph 2.a of the SBA October 2 Notice, then for purposes of determining the buyer group's eligibility for the ERTC, the buyer group will not be treated as having received a PPP Loan solely due to the existence of the target's PPP Loan. Accordingly, the buyer group, including the target, may claim the ERTC following the closing date, and any ERTC of the buyer group with respect to pre-transaction wages will not be subject to recapture. If the target does not fully satisfy the PPP Loan or submit a forgiveness application and establish an escrow prior to the closing date, any ERTC with respect to pre-closing wages are not subject to recapture, and the buyer group, but not the target, may claim the ERTC following the closing date.
FAQ 81b addresses asset acquisitions of a target with a PPP Loan outstanding as of the closing date. If the buyer does not assume the PPP Loan, the buyer group will continue to be eligible for the ERTC after the closing date and any ERTC claimed by the buyer group for qualified wages paid before the closing date will not be subject to recapture. If the buyer does assume the target's PPP Loan obligation, the result is similar; however, the wages paid by the buyer group after the closing date to any individual who was employed by the target on the closing date will not be eligible for the ERTC.
Deductibility of PPP Loan Expenditures If Forgiveness Has Not Been Determined by the End of the Taxable Year
On April 30, 2020, the IRS released Notice 2020-32, which provided that no deduction is allowed for an otherwise deductible expenditure if the payment of the expenditure results in forgiveness of a PPP Loan. Since that date, questions have arisen regarding the deductibility of PPP Loan expenditures if the PPP Loan is not forgiven in the same taxable year in which the expenditures are incurred.
On November 18, 2020, the IRS released the Revenue Ruling, which affirms that a borrower who incurs PPP Loan expenditures that would otherwise be deductible in 2020 may not deduct such expenditures if the borrower has a reasonable expectation that the PPP Loan will be forgiven, even if the PPP Loan is not forgiven in the taxable year in which the PPP Loan expenditures are incurred. The Revenue Ruling describes two scenarios. In the first scenario, the borrower applies for forgiveness of the PPP Loan in November 2020 and satisfied all the requirements under the CARES Act to have it forgiven, but as of December 31, 2020, the borrower does not know whether it will be forgiven. In the second scenario, the borrower has satisfied the CARES Act requirements for the loans to be forgiven by the end of 2020, but has not yet applied for forgiveness, and does not expect to apply for forgiveness until 2021.
In both scenarios, the IRS ruled that the PPP Loan expenditures were not deductible in 2020, because at the end of the taxable year, both borrowers knew the amount of their eligible expenses that qualified for reimbursement in the form of PPP Loan forgiveness and had a reasonable expectation of reimbursement. Since, forgiveness was foreseeable, the PPP Loan expenditures were not deductible in 2020.
On the same day, the IRS released the Revenue Procedure, which provides a safe harbor allowing borrowers to claim a deduction for PPP Loan expenditures incurred in a taxable year beginning or ending in 2020 (2020 taxable year) if 1) the PPP Loan expenditures are paid or incurred in the 2020 taxable year, 2) the borrower receives a PPP Loan and reasonably expects it to be forgiven in a subsequent taxable year, and 3) in a subsequent taxable year, the PPP Loan is not forgiven in whole or in part or the borrower decides not to seek forgiveness of such PPP Loan. If the safe harbor requirements are met, the borrower may deduct non-deducted eligible expenditures on its timely filed tax return or amended tax return for the 2020 taxable year or its tax return in a subsequent year, so long as the taxpayer includes an applicable "Revenue Procedure 2020-51 Statement" together with such tax return.
[1] The FAQs provide the IRS's current interpretation of the Employee Retention Credit provisions but may not be relied upon as legal authority and may be revised or updated.
