The Internal Revenue Service (IRS) recently clarified its guidance on the tax treatment of expenses paid with Paycheck Protection Program (PPP) loan proceeds that are not forgiven by the end of the year the loan was received. Taxpayers that reasonably expect, but have not yet received, PPP loan forgiveness are not allowed an income tax deduction for expenses paid with the loan proceeds according to Revenue Ruling 2020-27.
The IRS also addressed the steps a taxpayer should take if the taxpayer later finds that some, or all, of a PPP loan is not going to be forgiven. Specifically, Revenue Procedure 2020-51 establishes safe harbor procedures that an eligible taxpayer can follow to claim a tax deduction for expenses paid with PPP loan proceeds when the taxpayer is subsequently denied PPP loan forgiveness or when the taxpayer subsequently foregoes loan forgiveness.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act established the PPP loan program to provide loans to small businesses impacted by the COVID-19 pandemic. The program forgives the full principal amount of the loan up to the total amount incurred and paid for eligible expenses during the period February 15, 2020, to December 31, 2020. The program also excludes the forgiven amount from gross income. The expenses that are eligible for loan forgiveness are those paid for payroll, interest on a covered mortgage obligation, any covered rent obligation payment and any covered utility payment. While the IRS previously ruled in Notice 2020-32 that loan recipients are not eligible to deduct expenses paid with PPP loan proceeds when the loan is forgiven, there was confusion about the tax treatment of expenses paid in 2020 when the loan is not forgiven in 2020.
Revenue Ruling 2020-27: Deduction Denied
Revenue Ruling 2020-27 amplifies Notice 2020-32 and holds that a “taxpayer that received a [PPP] loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses . . . 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 the [PPP] loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.”
In other words, a taxpayer that reasonably expects to receive forgiveness of a PPP loan is not allowed an income tax deduction for expenses paid in 2020 with the PPP loan proceeds, even if the PPP loan is not forgiven until 2021.
Revenue Procedure 2020-51: Deduction Allowed
Revenue Procedure 2020-51 establishes safe harbor procedures that an eligible taxpayer can follow to claim a tax deduction for expenses paid with PPP loan proceeds when the taxpayer is subsequently denied PPP loan forgiveness or when the taxpayer subsequently foregoes loan forgiveness. The safe harbor established by Revenue Procedure 2020-51 permits an eligible taxpayer to deduct some or all of the eligible expenses on the taxpayer’s:
- Timely-filed (including extensions) original 2020 tax return;
- Amended 2020 tax return; or
- Timely-filed (including extensions) 2021 tax return.
A taxpayer applying the safe harbor must attach a statement titled “Revenue Procedure 2020-51 Statement” to the return on which the taxpayer deducts eligible expenses. To find the required information the statement must include, click here.
A taxpayer is eligible to use the safe harbor if the taxpayer:
- Has paid or incurred eligible expenses in the 2020 taxable year for which no deduction is permitted because, as of the end of 2020, the taxpayer reasonably expects the PPP loan to be forgiven based on those eligible expenses;
- Has submitted an application for loan forgiveness to the lender, or, as of the end of 2020, intends to submit an application for loan forgiveness in 2021; and
- In 2021 has the request for PPP loan forgiveness denied, in whole or in part, or decides not to request forgiveness of the PPP loan.
Can a Taxpayer Take a Contrary Position?
Some practitioners believe there is a reasonable basis to claim an income tax deduction for 2020 for expenses paid with PPP loan proceeds if the PPP loan is not forgiven in 2020. In such a case, a taxpayer would claim a deduction for the expenses on a 2020 tax return and disclose the contrary position on a Form 8275 or Form 8275-R to limit the taxpayer’s exposure to penalties.
A taxpayer considering taking this this position should, however, be aware that:
- Congress had an opportunity to explicitly permit taxpayers to deduct expenses paid with PPP loan proceeds when it passed the CARES Act and the Paycheck Protection Program Flexibility Act of 2020, but Congress failed to do so both times;
- The IRS is not likely to concede this issue if the taxpayer’s return is selected for audit;
- A taxpayer will likely incur significant professional fees to represent the taxpayer during an audit and even more fees to litigate this matter.
Thus, taking a position contrary to Revenue Ruling 2020-27 and Notice 2020-32 is an aggressive move and in most cases the risk of doing so likely will not be worth the reward.
If you have questions regarding your business expenses made with PPP loan proceeds on your 2020 tax return, contact us. We're here to help.