On November 18, 2020, the U.S. Treasury Department and Internal Revenue Service (“IRS”) issued new guidance clarifying the income tax treatment of expenses, when a Paycheck Protection Program (“PPP”) loan has not been forgiven by the end of 2020. This guidance provides additional clarification related to Notice 2020-32 issued earlier this year by the IRS regarding the income tax treatment of expenses (see below).
Rev. Rul. 2020-27 provides that taxpayers who paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act, may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of their PPP loan based on the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the PPP loan by the end of such taxable year.
The IRS offers two examples in this revenue ruling, regarding a taxpayer who receives a PPP loan in 2020, and pays eligible payroll and nonpayroll expenses with their PPP funds. In both situations, the borrowers have satisfied all requirements under section 1106 of the CARES for loan forgiveness.
- In Situation #1, the borrower applies for loan forgiveness before the end of 2020 on the basis of the eligible expenses it paid during the covered period, but does not receive a decision from their lender before December 31.
- In Situation #2, the borrower does not apply for loan forgiveness before the end of 2020, but expects to apply to the lender for forgiveness in 2021 on the basis of the eligible expenses it paid during the covered period.
The IRS concludes that in both of these situations, the borrowers knew the amount of eligible expenses that qualified for reimbursement and have a reasonable expectation of reimbursement (i.e., loan forgiveness) at the end of 2020. Since reimbursement is reasonably expected to occur (rather than being unforeseeable) a deduction of the eligible expenses for Federal income tax purposes is not allowed.
In the alternative, section 265(a)(1) of the Internal Revenue Code disallows a deduction of otherwise deductible eligible expenses because the expenses are allocable to tax-exempt income in the form of reasonably expected covered loan forgiveness.
The IRS also issued Rev. Proc. 2020-51 on November 18. This revenue procedure provides a safe harbor allowing a taxpayer to claim a deduction for the 2020 tax year for certain otherwise deductible eligible expenses, if:
(1) the eligible expenses are paid or incurred during the taxpayer’s 2020 tax year,
(2) the taxpayer receives a PPP loan, which at the end of the taxpayer’s 2020 tax year, the taxpayer expects to be forgiven in a subsequent taxable year, and
(3) in a subsequent taxable year, the taxpayer’s request for forgiveness of the covered loan is denied, in whole or in part, or the taxpayer decides never to request forgiveness of the covered loan.
If a taxpayer meets these requirements, they 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 for the 2020 tax year; (2) an amended return or an administrative adjustment request (AAR) under section 6227 of the IRC for the 2020 tax year; or (3) the taxpayer’s timely filed (including extensions) original income tax return or information return for the subsequent tax year.
The revenue procedure establishes which taxpayers are eligible for the safe harbor and provides guidelines for using the safe harbor procedures, including limitations on the amount that can be deducted for eligible expenses (i.e., taxpayers cannot deduct eligible expenses in excess of the principal amount of the PPP loan for which forgiveness was denied or not applied for). Taxpayers must also attach a statement titled “Revenue Procedure 2020-51 Statement” to the tax return on which they are deducting the eligible expenses, providing information on their PPP loan and the expenses being deducted.
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Earlier this year, the IRS provided guidance in Notice 2020-32 regarding the deductibility for Federal income tax purposes of certain otherwise deductible expenses incurred by a taxpayer’s business, when the taxpayer receives a covered loan (PPP) under the CARES Act. This notice stated that no deduction is allowed under the Internal Revenue Code for an expense that is otherwise deductible, if the payment of the expense results in forgiveness of a covered loan, and the income associated with the forgiveness is excluded from gross income pursuant to section 1106(i) of the CARES Act.¹
This notice is alerting taxpayers who intend to seek forgiveness on their PPP loans, that they will not be able to deduct otherwise deductible expenses (i.e., payroll, mortgage interest, rent, utilities, interest on other existing debt obligations) if those expenses were paid using a PPP loan that was ultimately forgiven. Shortly after this notice was released, many members of Congress made statements or issued press releases indicating that disallowing PPP-related business expenses for Federal income tax purposes was contrary to Congressional intent. This notice also sparked the introduction of a number of bills to clarify the treatment of expenses related to forgiven loans.
“When we developed and passed the Paycheck Protection Program, our intent was clearly to make sure small businesses had the liquidity and the help they needed to get through these difficult times. Unfortunately, Treasury and the IRS interpreted the law in a way that’s preventing businesses from deducting expenses associated with PPP loans. That’s just the opposite of what we intended and should be fixed. This bill will do just that,” – Senate Finance Committee Chairman Chuck Grassley (R-IA)
“The Paycheck Protection Program has been a lifeline to small businesses in Texas during the coronavirus pandemic. This legislation would erase any confusion by clarifying that expenses paid with a forgiven PPP loan can still be deducted from small businesses’ taxes.” – Senator John Cornyn (R-TX)
“Treasury’s guidance barring deductions for expenses paid by PPP loans is a gut punch for businesses struggling to stay afloat. It defies commonsense for Treasury to provide help on the front end, but then take it away on the back end. Our bipartisan bill would fix this mistake and ensure businesses feel confident using PPP funds to keep their workers employed.” – Senator Ron Wyden (D-OR)
As of this posting, Congress has not passed any legislation that would undo or correct the guidance issued by the IRS in Notice 2020-32, despite several standalone bills being introduced in the House of Representatives and Senate. There is also language correcting this treatment included in various stimulus bills proposed by Congressional leaders. However, the White House and Congress have not been able to break their stalemate over stimulus funding, and negotiations have been at an impasse since October.
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For additional information on the Paycheck Protection Program, as well as other Federal, state and local relief measures, please visit our COVID-19 Resource Center on our website. If you have any questions, please contact your Tronconi Segarra & Associates advisor or a member of our response team at covid19team@tsacpa.com
¹ Section 1106(i) of the CARES Act provides an exclusion for purposes of the Internal Revenue Code, for any category of income that may arise for a PPP borrower due to forgiveness of their covered loan.
