Morris Manning & Martin, LLP

IRS Confirms Eligible Expenses Are Not Deductible in 2020 if PPP Loan Forgiveness is Expected in Later Year

12.02.2020

On November 18, 2020, the IRS released Revenue Ruling 2020-27 stating that a taxpayer who received a Paycheck Protection Program (PPP) loan cannot deduct eligible business expenses (i.e., payroll costs, mortgage loan interest, rent payments and utility payments) paid or incurred in 2020 during the covered period (as defined below) if the taxpayer reasonably expects that the PPP loan will be forgiven in the future. The IRS also released Revenue Procedure 2020-51, which provides a safe harbor allowing deductions for eligible business expenses for (i) taxpayers who decide not to seek PPP loan forgiveness and (ii) taxpayers whose PPP loan forgiveness is denied.

Background

The PPP program was enacted as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. PPP loans may qualify for tax-free forgiveness if eligible business expenses are paid or incurred before the earlier of (i) 24 weeks following the receipt of the PPP loan or (ii) December 31, 2020 (the covered period). On April 30, 2020, the IRS published Notice 2020-32 clarifying that no deduction will be allowed for eligible business expenses otherwise deductible by a taxpayer receiving a PPP loan that is later forgiven because of such expenses. Notice 2020-32 left open the issue of whether a taxpayer should deduct such expenses in 2020 if the PPP loan has not been forgiven by the end of the year. Revenue Ruling 2020-27 amplifies Notice 2020-32 and provides guidance regarding this issue.

Revenue Ruling 2020-27

In Revenue Ruling 2020-27, the IRS provided two examples illustrating its position on nondeductibility of eligible expenses paid or incurred by PPP loan recipients. In the first example, a taxpayer paid eligible expenses in 2020 during the covered period and applied for PPP loan forgiveness the same year. Although the taxpayer did not receive a determination on forgiveness by the end of 2020, the taxpayer was not allowed to deduct the eligible expenses because the taxpayer had a reasonable expectation of forgiveness of the PPP loan in the future. In the second example, a taxpayer paid eligible expenses in 2020 during the covered period but did not apply for PPP loan forgiveness until 2021. Again, the IRS took the position that the eligible expenses were nondeductible because the taxpayer reasonably expected loan forgiveness in the future. In both examples, the reasonable expectation of forgiveness was based on the fact that the businesses incurred eligible business expenses within the covered period.

Revenue Procedure 2020-51

In Revenue Procedure 2020-51, the IRS created a safe harbor generally allowing a taxpayer receiving a PPP loan to later claim a deduction for eligible business expenses not deducted in 2020 pursuant to Revenue Ruling 2020-27 if the taxpayer’s PPP loan is later denied forgiveness (or the taxpayer later decides not to seek forgiveness). If a taxpayer’s PPP loan forgiveness is fully or partially denied (or the taxpayer decides not to seek forgiveness), it can claim deductions for eligible business expenses paid or incurred on its timely filed 2020 return, on an amended 2020 return or “administrative adjustment request,” or on its return for the subsequent year. A taxpayer qualifying for this safe harbor must attach a statement to its tax return providing certain specified information regarding the taxpayer’s PPP loan and eligible business expenses paid or incurred.

Next Steps

Although the IRS’ position in Revenue Ruling 2020-27 is not surprising, many practitioners and lawmakers remain unhappy with the general nondeductibility of PPP loan proceeds. Any changes with respect to this issue will have to come from Congress.

Further guidance is still needed with respect to some more technical tax issues involving PPP loans (e.g., whether wages paid with PPP loan funds are counted in the Section 199A deduction calculation).

If you have any questions about this legal update, please do not hesitate to reach out to the authors or any of your contacts at Morris, Manning & Martin, LLP.