IRS updates guidance to reflect legislation on expense deductibility under the PPP

Eversheds Sutherland (US) LLPIn light of recent Congressional action, the IRS has obsoleted its prior guidance that deductions of business expenses taken by recipients of forgiven loans under the Paycheck Protection Program (PPP) are disallowed. On December 27, 2020, Congress passed the Consolidated Appropriations Act of 2021 (the CAA). The CAA funds the government until October 2021 and provides roughly $900 billion in coronavirus aid.  Included in the aid is an additional $284 billion for a second round of PPP loans.  Among other things, the CAA clarifies that otherwise deductible expenses paid for by a recipient of a PPP loan continue to be deductible even if the PPP loan is forgiven in accordance with the statute. This clarification applies to taxpayers that received PPP loans made under the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) or under the CAA. On January 5, the IRS issued Revenue Ruling 2021-02 to obsolete Revenue Ruling 2020-27 and Revenue Procedure 2020-51, and reflect this statutory change.

Under the CARES Act, businesses were eligible to receive PPP loans to aid in maintaining employees throughout the economic crisis caused by the COVID-19 pandemic. If loan recipients abide by several requirements, then they are eligible for loan forgiveness. The CARES Act specifically provides that in any circumstances in which a PPP loan is forgiven, the taxpayer does not recognize cancelation of indebtedness income under section 108.1  

Following the enactment of the CARES Act, in Notice 2020-32, the IRS took the position that expenses paid by those with a forgiven PPP loan were not deductible for U.S. federal income tax purposes. (See prior Legal Alert.) In Revenue Ruling 2020-27 and Revenue Procedure 2020-51, the IRS expanded on its conclusion in the Notice, reasoning that expenses were not deductible if the taxpayer reasonably expected forgiveness of the PPP loan.2 The position of the IRS ran counter to statements made by members of Congress as to the legislative intent. 

Section 276 of the CAA provides that “no amount shall be included in the gross income of the eligible recipient by reason of forgiveness of indebtedness.” In addition, to provide certainty regarding deductibility, section 276 amends section 1106 of the CARES Act by providing that “no deduction shall be denied or reduced, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income” as provided under section 276. The statute leaves no question that taxpayers receiving PPP loans are entitled to deduct their ordinary business expenses.  Also prominent is the clarification that no tax attribute shall be reduced and no basis increase shall be denied by reason of this exclusion from gross income.3 The provisions apply retroactively to taxable years ending after March 27, 2020, (i.e., the date of the enactment of the CARES Act), making them effective for any prior or subsequently distributed PPP loan.4

Responding quickly to the CAA, the IRS released Rev. Rul. 2021-02, rendering Notice 2020-32 and Rev. Rul. 2020-27 obsolete. These clarifying provisions of the CAA are particularly beneficial to taxpayers that received PPP loans and may have been uncertain as to whether those loans would be forgiven at the time of filing their tax returns. Uncertainty is also eliminated for taxpayers receiving loans under the second round of the PPP that was authorized by the CAA.

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1 Section 1106(i) of the CARES Act; 15 U.S.C. §§ 636(a), 9005(c)(1), (j).
2 Because the CARES Act provided that forgiven PPP loans would represent non-taxable income to the loan recipient, the IRS viewed corresponding deductions as falling under the purview of section 265(a)(1), which disallows a deduction for any expense allocable to a class of tax-exempt income.
3 Section 276 of the Consolidated Appropriations Act of 2021. 
4 Section 276(a)(2) of the Consolidated Appropriations Act of 2021.

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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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