The Internal Revenue Service (IRS) recently issued a Revenue Ruling, a Revenue Procedure and a series of frequently asked questions (FAQs) posted on the IRS website addressing open questions regarding Paycheck Protection Program (PPP) loans.
- Revenue Ruling 2020-27 reaffirms, despite strong criticism from Congressional lawmakers, the position taken by the IRS in Notice 2020-32 that taxpayers are not allowed to deduct expenses paid with proceeds of PPP loans if such loans are expected to be forgiven.
- Revenue Procedure 2020-51 permits taxpayers to claim deductions for amounts paid using PPP loan proceeds in certain circumstances where part or all of such PPP loan is not forgiven.
- The IRS FAQs regarding the interaction of employee retention tax credits (ERTCs) and PPP loans, have been expanded to address considerations raised by common acquisition transactions. Generally, under the FAQs, employers are not precluded from claiming ERCTs solely as a result of acquiring a business that obtained a PPP loan.
The guidance, and considerations for taxpayers, are discussed in greater detail below.
I. CARES Act, PPP loans and the ERTC
The Coronavirus Aid, Relief, and Economic Security Act of 2020 (CARES Act) was enacted in March as part of an ongoing effort to combat the financial crisis arising from the COVID-19 pandemic. Making available forgivable PPP loans through the Small Business Administration (SBA) and refundable tax credits in the form of ERCTs to businesses were two key components of the CARES Act’s relief efforts.
Specifically, section 1102 of the CARES Act expanded the existing SBA Section 7(a) loan program to provide 100% federally-backed loans to eligible businesses (i.e., PPP loans). Under the CARES Act, PPP loans are eligible for loan forgiveness subject to certain conditions, including that the taxpayer incurs payroll and certain other qualifying operating expenses. The CARES Act provides that the amount of the loan forgiveness is not included in the taxpayer’s gross income for US federal income tax purposes.
In addition, section 2301 of the CARES Act provides the ERTC as a refundable payroll tax credit for 50% of certain “qualified wages” paid by employers to employees during the COVID-19 crisis. The ERTC is available to employers whose: (1) operations were fully or partially suspended, due to a COVID-19 related shutdown order, or (2) gross receipts declined by more than 50% when compared to the same quarter in the prior year. The ERTC is provided for wages paid or incurred from March 13, 2020, through December 31, 2020.
If an employer, or any entity in its aggregated group as defined in section 2301(d) in the CARES Act, receives a PPP loan, the employer is not eligible for the ERTC.
II. Rev. Rul. 2020-27 and Rev. Proc. 2020-51: Limited deductibility of expenses where PPP loan is forgiven
In Rev. Rul. 2020-27, the IRS doubled down on the position it took in Notice 2020-32, with respect to deduction of eligible expenses listed in section 1106(b) of the CARES Act (i.e., payroll costs, covered mortgage interest, rent and utilities), concluding that such amounts cannot be deducted if the taxpayer reasonably expects forgiveness of a PPP loan on the basis of such expenses. The ruling reasons that because the taxpayer reasonably expects reimbursement of the expenses through the forgiveness of the PPP loan, the deduction of such expenses is not appropriate. In the alternative, the ruling concludes that the deductions are disallowed under section 265(a)(1), which generally prohibits deductions for amounts allocable to wholly exempt income.
|Eversheds Sutherland Observation: The authorities cited in Rev. Rul. 2020-27 are factually distinguishable from the forgiveness of PPP loans. Expenses exceeding a certain threshold are a requirement for a PPP loan to be eligible for forgiveness. The forgiveness of a PPP loan under the CARES Act is not a reimbursement of such expenses, rather it is the cancelation of an obligation. Moreover, the expenses at issue are operating expenses the taxpayer incurred in the operation of its business, not expenses incurred in order to generate tax-exempt income (i.e., the PPP loan proceeds), which are the target of section 265(a)(1). It is notable that the Chairmen of the Senate Finance Committee have encouraged the IRS to reconsider its position in the Revenue Ruling (see Chairmen’s News here).
Rev. Rul. 2020-27 also addresses questions that were raised with respect to situations where a taxpayer does not file for forgiveness until after the end of the tax year. The ruling concludes that if the taxpayer expects to file for relief then the qualifying expenses are not deductible, regardless of the year in which the claim for forgiveness is made.
Rev. Proc. 2020-51 provides relief for taxpayers that fail to claim deductions for operating expenses incurred during a year in which the taxpayer had a PPP loan outstanding, if the forgiveness of part or all of such loan is subsequently denied. A taxpayer that is eligible for the relief may be able to deduct some or all of the eligible expenses on (1) the taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for the 2020 taxable year; (2) an amended return or an administrative adjustment request (Code section 6227) for the 2020 taxable year, as applicable; or (3) the taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for the subsequent taxable year.
|Eversheds Sutherland Observation: The recognition in Rev. Proc. 2020-51 that there are circumstances under which anticipated loan forgiveness may not be forthcoming runs counter to the apparent presumption by the IRS in the Rev. Rul. 2020-27 that any taxpayer meeting the expense thresholds will be eligible for “reimbursement” of such expenses.
III. FAQ 81a and 81b: Acquisition of target with PPP loan has limited impact on acquirer’s ERTCs
Separately, the IRS issued FAQs addressing the interplay of PPP loans and ERTCs. As noted above, a taxpayer that receives a PPP loan is not eligible for ERTCs. Because aggregate group rules apply in identifying the “employer” under these rules, concerns had been raised as to whether the acquisition of a target entity that has a PPP loan would cause the acquiring employer to not be eligible for ERTCs.
In the case of stock acquisitions, IRS FAQ 81a provides generally that:
- If a target’s existing PPP loan is fully satisfied (or a repayment escrow is established) prior to the closing date, then the acquirer and its aggregate group are not treated as having received a PPP loan as a result of the acquisition (meaning previously claimed ERTCs are not impacted and the aggregate group is eligible to claim ERTCs after closing) and the target entity can claim ERTCs after the closing.
- If a target’s existing PPP loan is not fully satisfied (and no repayment escrow is established) prior to the closing date, then the acquirer and its aggregate group (other than target) are not treated as having received a PPP loan as a result of the acquisition, but the target entity cannot claim ERTCs after the closing.
Similar rules are provided for asset acquisitions in IRS FAQ 81b:
- If an acquirer acquires the assets and liabilities of a target that had received a PPP loan, but without assuming the target’s obligations under the PPP loan, then the acquirer and its aggregate group will not be treated as having received a PPP loan as a result of the acquisition.
- If an acquirer acquires the assets and liabilities of a target that had received a PPP loan, including the target’s obligations under the PPP loan, then the acquirer and its aggregate group generally will not be treated as having received a PPP loan as a result of the acquisition; however, the wages that may be treated as qualified wages after the closing date will be limited.
|Eversheds Sutherland Observation: As helpful as the added FAQs are with respect to the treatment of PPP loans and ERTCs in the context of stock and asset acquisitions, they fail to cover (at least explicitly) taxable and non-taxable merger transactions. This appears to be an unintended oversight and it is reasonable to conclude that that the rules under FAQ 81a and 81b should likewise apply to such merger transactions.
|Eversheds Sutherland Observation: The new FAQs provide helpful guidance for acquirers, although, like other FAQs on the IRS website, the IRS states that they cannot be relied upon as legal authority.