Take “CARES” When Reviewing 2020 Business Returns

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It has been a very long, if not a very good year.  We noted in an earlier post that one of the challenges reserved for 2021 would be to see how the IRS would address the dischargeable loans granted to hundreds of thousands of businesses under the Paycheck Protection Program (PPP).  Recall that those who “borrowed” under that program were eligible to have the loan forgiven if it was shown that the funds were deployed to cover: (a) payroll; (b) mortgage interest; (c) rent; and, (d) utilities.

The CARES Act specified that the discharge of the loan by itself would not be income.  Section 1106(b).  A Notice issued in May (No. 2020-32) signaled that the taxpayer could not take a deduction for expenses that were effectively paid by a loan that had been discharged.

We now have Revenue Ruling 2020-27 confirming much of this.  Even if the PPP loan has not been formally discharged, the expenses paid with that loan are not deductible if the taxpayer expects the loan to be forgiven at the time of filing.  In fact, the deduction is denied even if forgiveness has not yet been requested so long as the money was spent for one of the four qualified purposes specified above as (a-d).

The IRS also issued Revenue Procedure 2020-51.  It covers the back door in the event that the PPP loan is not forgiven.  Where the lender denies PPP loan forgiveness and the taxpayer wishes to claim the deduction because the expense was paid from revenue and not the money disbursed under the PPP loan, the taxpayer has to attach a statement to the return setting forth the history of what occurred, and how/when the indebtedness was not discharged.  The specifics can be ascertained by reference to the IRS documents.  A summary of it is found in an Alert titled, IRS Confirms Non-Deductibility of Expenses Related to PPP Loans, published by the Tax & Wealth Planning attorneys at Fox Rothschild.

When reviewing a tax return for purposes of calculating support obligations or in determining the value of a business, the practitioner should be aware that these rules should affect income/valuations and should beware that some taxpayers will not avoid the temptation to deduct expenses even though they were effectively payed by the IRS.  Every business should have kept a ledger specifying what expenses were allocated to the PPP loan in order to qualify for discharge of the loan.  That ledger needs to be a part of any discovery request you make henceforth.

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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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