Since the IRS issued Notice 2020-32, PPP borrowers and their advisors have questioned whether they can deduct forgivable expenses paid with PPP loan proceeds on their 2020 tax returns if the loan will not be forgiven until 2021. On November 18, 2020, the IRS released Revenue Ruling 2020-27 and Revenue Procedure 2020-51 resolving the timing issues related to PPP loan forgiveness and the deductibility of related PPP expenses. In the guidance, the IRS confirms that PPP expenses paid in 2020 may not be deducted if the taxpayer reasonably expects to receive forgiveness of the loan, even if the loan forgiveness application is not submitted by the of 2020.
The CARES Act, which enacted the Paycheck Protection Program (PPP), explicitly provides that forgiveness of PPP loans does not trigger taxable income, stating that income deemed to arise from the debt forgiveness is excluded from gross income. However, immediately the question arose as to whether expenses paid with forgiven PPP loans would be deductible. The IRS responded by releasing Notice 2020-32 on May 1, 2020. Notice 2020-32 clarified that, to prevent a double tax benefit, no deduction is allowed for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP loan, and the income associated with the forgiveness is excluded from gross income.
The phrasing “results in forgiveness” implied that forgiveness needed to happen for the non-deductibility rule to kick in. However, Notice 2020-32 did not say when a taxpayer recognizes the income, whether that is at the time the PPP loan is forgiven or when the expenses are incurred.
Congress subsequently passed the Paycheck Protection Program Flexibility Act (Flexibility Act), which extended the covered period for paying forgivable expenses from eight weeks to 24 weeks and provided that a borrower applies for forgiveness within 10 months of the end of its covered period. These changes meant that the 2020 taxable year of most PPP borrowers will end prior to their securing PPP loan forgiveness in 2021.
This latest guidance clarifies the IRS’s position that the actual filing of the forgiveness application will not change the timing of the non-deductibility of the PPP expenses if the borrower reasonably expects to receive forgiveness.
Revenue Ruling 2020-27
Rev. Rul. 2020-27 confirms that a taxpayer may not deduct PPP expenses (i.e., payroll costs, mortgage interest, utilities, rents) in the taxable year in which the expenses were paid if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the PPP loan on the basis of the expenses it paid during the covered period, even if the taxpayer has not submitted a loan forgiveness application by the end of such taxable year.
The ruling addresses two scenarios. In the first scenario, a borrower pays expenses, such as payroll and mortgage interest, that qualify as eligible PPP expenditures. The borrower applies for forgiveness in November 2020 and satisfied all the requirements under the CARES Act to have the loan forgiven, but by the end of the year the loan has not yet been forgiven. In the second scenario, the borrower pays the same expenses with his/her PPP loan and also satisfied the CARES Act requirements for the loan but expects to apply for forgiveness in 2021. According to the ruling, the borrowers in both scenarios cannot deduct the expenses funded with their PPP loans on their 2020 tax returns because they have a reasonable expectation of forgiveness.
The ruling does not provide further insight into the term “reasonably expects to receive forgiveness.” For example, could a borrower argue that the expectation of forgiveness is unforeseeable where the taxpayer’s “economic need” for the PPP loan will be subject to review by the Small Business Administration? The guidance also does not address the order in which the eligible expenses (payroll, rent, utilities and mortgage interest) lose the ability to be deducted, nor does it address other considerations including how the deductibility issue will impact the business interest expense limitation or the qualified business income deduction.
Revenue Procedure 2020-51
The IRS also issued a separate revenue procedure to protect taxpayers who ultimately have their PPP loan forgiveness application partially or fully denied. Rev. Proc. 2020-51 provides a safe harbor for PPP borrowers who paid eligible PPP expenses during the 2020 tax year and reasonably expect to receive forgiveness at the end of year, but in 2021 either the borrower’s loan forgiveness is partially or fully denied, or the borrower decides not to apply for loan forgiveness.
- The taxpayer may deduct the expenses that do not result in loan forgiveness on the taxpayer’s timely filed (including extensions) original tax return, amended return or administrative adjustment request (AAR) for the 2020 tax year; or
- The taxpayer may deduct these expenses on the taxpayer’s timely filed (including extensions) original tax return for the 2021 tax year. This flexibility could be a planning opportunity for eligible PPP borrowers.
There is still hope that Congress will pass bipartisan legislation that will over-rule the IRS’s position and ensure that PPP loan forgiveness has no impact on the deductibility of expenses paid from PPP loan proceeds that are forgiven, and it is possible that the latest IRS guidance will spur action in Congress.
Lawmakers will continue their efforts to include language in year-end legislation clarifying that taxpayers qualify for expense deductions even if their loans are forgiven, which could be included in government spending legislation that Congress must pass by December 11, 2020.
Most PPP loan borrowers still have time to apply for forgiveness, as the deadline is 10 months from the end of the loan’s covered period. We continue to generally recommend that borrowers wait to apply for loan forgiveness, but you should review your circumstances with a Bennett Thrasher advisor.
Bennett Thrasher will continue to monitor developments concerning the deductibility of forgiven PPP loan proceeds. If you have further questions regarding tax deductions relating to PPP loans or any other concerns regarding loan forgiveness please contact your BT advisor or call 770.396.2200.