No harm, no foul: IRS guidance provides path to claim PPP-related deductions for taxpayers who followed its earlier - but now obsolete - advice

Eversheds Sutherland (US) LLPThe Internal Revenue Service (IRS) recently issued Revenue Procedure 2021-20 (Revenue Procedure), providing guidance for taxpayers who received Paycheck Protection Program (PPP) loans in 2020 but did not deduct all of their otherwise-deductible expenses. This is the latest step in the IRS’s reversal of its initial position to disallow such deductions, which drew swift and unequivocal rebuke from Congress.

Congress created the PPP lending facility through the CARES Act to help small businesses weather the economic crisis caused by the COVID-19 pandemic. If borrowers followed the statutory requirements, Congress also provided loan forgiveness and excluded such forgiven debt from income.

Following the enactment of the CARES Act, in Notice 2020-32 (Notice), the IRS took the position that expenses paid by borrowers with a forgiven PPP loan were not deductible for US federal income tax purposes (see prior Legal Alert). In Revenue Ruling 2020-27 and Revenue Procedure 2020-51, the IRS doubled down on its conclusion in the Notice, reasoning that expenses were not deductible if the taxpayer reasonably expected forgiveness of the PPP loan.

Not only was the IRS position counter to statements made by members of Congress as to its legislative intent, but the authorities cited as support were factually distinguishable from the forgiveness of PPP loans. As noted in another prior Legal Alert, one of the fundamental requirements for PPP loan forgiveness is that relevant expenses meet certain benchmarks. Loan forgiveness is not a reimbursement of those expenses; it is cancellation of the borrower’s obligation to repay the PPP loan. Shortly after the IRS published this position, the Chairman of the Senate Finance Committee encouraged the IRS to reconsider its position (see Chairman’s News here).

When Congress passed the Consolidated Appropriations Act (CAA) of 2021, it included unequivocal statutory language ensuring that otherwise deductible expenses paid or incurred by a recipient of a PPP loan continue to be deductible even if the PPP loan is forgiven. Congress also expanded the scope of qualifying expenses for PPP borrowers—old and new—and created a second draw for PPP loan recipients (see our prior Legal Alert for further details).

On January 5, the IRS issued Revenue Ruling 2021-02 to obsolete Revenue Ruling 2020-27 and Revenue Procedure 2020-51, and to reflect this statutory change. And, on April 22, 2021, the IRS issued the Revenue Procedure, providing a safe harbor for taxpayers who followed the IRS’s earlier guidance with respect to the deductibility of certain expenses paid with PPP loan proceeds. For those taxpayers who forewent claiming deductions, the Revenue Procedure explains how to retroactively obtain the tax benefits that Congress intended from the outset. The Revenue Procedure provides a safe harbor process for “covered taxpayers,” i.e., those who:

(1) received an “original” PPP covered loan;
(2) paid or incurred “original eligible expenses” during the 2020 taxable year;
(3) timely filed a federal tax return prior to December 27, 2020 (presumably tied to the effective date of the CAA); and
(4) did not claim deductions for eligible expenses because either:
          (a) the expenses resulted in forgiveness of the original PPP covered
               loan; or
          (b) the taxpayer reasonably expected at the end of the 2020 taxable year that the expenses would result in such forgiveness.

Through normal procedures, taxpayers may still file amended returns or administrative adjustment requests, but through this safe harbor, qualifying taxpayers may also file a “Revenue Procedure 2021-20 Statement” (Statement) with their next federal income tax returns. Among other things, the Statement should include the amount and date of disbursement of the taxpayer’s original PPP covered loan; and a list, including descriptions and amounts, of the original eligible expenses paid or incurred during the 2020 taxable year.

Eversheds Sutherland Observation: Although the Revenue Procedure ostensibly “allows” these deductions, it unnecessarily complicates matters because, without support, it draws a line in the sand between original PPP-eligible expenses and those additional expenses that Congress added to the list in the CAA. 

The guidance may not be as helpful to taxpayers as it appears. It only applies to taxpayers who filed returns prior to December 27, 2020, which would exclude taxpayers with a calendar year-end. Moreover, it is likely the case that taxpayers would prefer to file an amended return rather than wait another year to take advantage of their full deductions.

It is important for taxpayers considering whether to take advantage of this procedure to note that while the safe harbor allows the deductions to be claimed, it does not prevent the IRS from examining any deduction-related issues or requesting substantiating documentation.

[View source.]

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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