Update: President Trump signed the Consolidated Appropriations Act of 2021 on December 27, 2020, and the IRS issued Revenue Ruling 2021-02 on January 6, 2021, rescinding Notice 2020-32 and Revenue Ruling 2020-27.
Borrowers can now deduct ordinary business expenses paid for using Paycheck Protection Program (PPP) loan proceeds. This change in the tax treatment of deductions will help to increase the tax benefit of forgivable loans under the PPP program in an attempt to further increase liquidity for borrowers and help them retain employees. The changes apply to both the original recipients of PPP loans under the Coronavirus Aid, Relief, and Economic Security (CARES) Act as well as to new recipients under the reauthorization of the program.
The COVID-related Tax Relief Act of 2020, which is part of the Consolidated Appropriations Act of 2021, included the changes along with more than $284 billion in additional PPP funds. Section 276 of the COVID-related Tax Relief Act of 2020 states that “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income…” The bill has been presented to President Donald Trump, who is expected to sign it into law.
Act Reverses IRS Position
The CARES Act established the PPP program, which provided that emergency loans made under Section 7(a) of the Small Business Act (SBA) were eligible for loan forgiveness and the forgiven amount is excluded from taxable income. The CARES Act, however, did not address whether borrowers can deduct otherwise allowable deductions for ordinary and necessary business expenses paid with loan proceeds if the covered loan is subsequently forgiven.
The IRS subsequently issued Notice 2020-32, which applied IRC Section 265(a)(1) and reasoned that, to prevent a double tax benefit, no deduction was allowed for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan under the PPP and the income associated with the forgiveness is excluded from gross income. The IRS position meant that any forgiven PPP loan amount results in a corresponding reduction in allowable deductions.
In November 2020, the IRS solidified its position on allowable deductions when it clarified the treatment of expenses paid with PPP loan proceeds when the loan is not forgiven by the end of the year it was received. In Revenue Ruling 2020-27, the IRS held that taxpayers that reasonably expect, but have not yet received, PPP loan forgiveness are denied a tax deduction for expenses paid with the loan proceeds. Also, in Revenue Procedure 2020-51, the IRS established safe harbor procedures that an eligible taxpayer can follow to claim a deduction for expenses paid with PPP loan proceeds when the taxpayer later finds that some or all of a PPP loan will not be forgiven.
Leaders of the congressional tax-writing committees have opposed the IRS’s position and indicated that they would address the issue in future legislation. The congressional leaders criticized the IRS position as against the intent of the PPP and contrary to the expectations of loan recipients. Other critics noted that the disallowances eliminated the tax benefit of the exclusion of the forgiveness amount from taxable income.
For assistance with the PPP deductions or if you have questions, contact us. We are here to help.
The time for forgiveness is here. Now that the Small Business Administration’s (SBA) Paycheck Protection Program Forgiveness Application is live,…