The Paycheck Protection Program (“PPP”) loans provided welcome relief to businesses across the country that were and are dealing with the effects of COVID-19. Namely, a recipient of a PPP loan who uses funds to pay for certain defined expenses can potentially have that loan forgiven. While the forgiveness of the loan in and of itself was a significant benefit to cash-strapped businesses, the Coronavirus Aid, Relief, and Economic Security Act (“CARES”) Act provided an additional tax benefit—specifically providing that the forgiveness of the PPP loans did not generate gross income to the taxpayers, which is a departure from the traditional tax treatment of forgiven loans.
However, soon after the enactment of the CARES Act, the IRS limited the tax benefits of the exclusion of the loan forgiveness from income. Specifically, in Notice 2020-32, the IRS provided to the extent that a PPP loan was forgiven, no deduction was allowed for those expenses that were paid for with the loan proceeds, thus essentially nullifying the tax benefit the taxpayers received from excluding the loan forgiveness from income. The Department of Treasury and IRS have reinforced this position with recently issued technical guidance regarding how to report those expenses incurred with the loan proceeds.
The first piece of guidance, Revenue Ruling 2020-27, reiterates the IRS position that expenses covered by a PPP loan that is forgiven cannot be deducted for federal income tax purposes. It then goes on to provide guidance on the timing issues that will confront many taxpayers who received PPP loans in 2020 but will not have a decision from the federal government until after the tax year has ended as to whether the loan is forgiven. Specifically, the ruling provides that if there is a reasonable expectation that the loan will be forgiven, the deductions for the related expenses incurred are disallowed for the 2020 tax year.
The Revenue Ruling provides two examples in which the taxpayer utilized the PPP loan on eligible expenses. In the first example, the taxpayer applied to its lender for forgiveness prior to the end of 2020 but had not yet received answer. In the second example, the taxpayer had not yet applied for forgiveness but intended to do so in 2021. The Department ruled that, in both situations, the expenses were not deductible in 2020 because the taxpayers had a reasonable expectation of forgiveness, regardless of whether an application for forgiveness had been filed.
In corresponding guidance, Revenue Procedure 2020-51 outlines the processes that can be utilized for a taxpayer who doesn't take a deduction for certain expenses because it reasonably expects to have the loan forgiven (because of Rev. Rul. 2020-27) and later has the forgiveness denied or irrevocably decides not to seek forgiveness. The IRS provides those expenses that previously were not deductible can be deducted if the loan is not forgiven and provides safe harbors that allow a taxpayer to deduct such expenses on either: (1) the taxpayer's original income tax return for the 2020 taxable year; (2) an amended return for the 2020 taxable year; or (3) the taxpayer's original income for the subsequent taxable year. There are filing requirements to take advantage of these safe harbors, but the primary message from this Revenue Procedure is that if loan forgiveness is denied or not utilized for PPP loans, the taxpayer is then able to take deductions for the corresponding expenses—and the taxpayer has the flexibility of determining which tax year to utilize those deductions.
While this guidance is consistent with the original IRS position related to forgivable PPP loans, it details and illustrates timing issues that have been created for many taxpayers by having incurred the likely non-deductible expenses in one year without having a conclusive answer from the federal government as to whether the loan is, in fact, going to be forgiven until after that year has concluded.
To the extent that you have any questions regarding the tax treatment of your PPP loans, please feel free to contact Matt Ehinger, Josh Schlake or the Ice Miller's Tax Group attorney with whom you work.
Originally Published by Ice Miller, November 2020
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