Taxpayers have received additional guidance from the IRS regarding the deductibility of expenses paid for with Paycheck Protection Program loans, but not in the direction many would have appreciated.
Background. First, pursuant to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, a taxpayer who received a PPP loan is generally eligible to receive forgiveness of the loan if it used the proceeds for certain eligible expenses listed in the CARES Act. Second, in guidance issued this May (IRS Notice 2020-32), the IRS has taken the position that a taxpayer receiving a PPP loan cannot take a deduction for any eligible expenses it pays for with the PPP loan proceeds (PPP Expenses). The rationale for this position comes from Internal Revenue Code (IRC) Section 265, which denies deductions for expenses related to tax-exempt income. The IRS views a forgiven PPP loan as tax-exempt income to the taxpayer and the PPP expenses as directly related to that income. This guidance did not address the timing issue of receiving forgiveness for a PPP loan in a year later than the year in which when the PPP expenses were incurred.
New Guidance – Timing of Non-Deductibility of PPP Expenses. In mid-November, the IRS issued Revenue Ruling 2020-27, which provides further guidance on the timing of the non-deductibility of PPP expenses. In short, if the taxpayer has a “reasonable expectation” of PPP loan forgiveness, the PPP expenses are not deductible in 2020. This is the case even if the taxpayer has not received forgiveness for the PPP loan before the end of 2020. Pursuant to the IRS guidance, a “reasonable expectation” includes: (i) incurring eligible expenses, satisfying the other requirements under the CARES Act for forgiveness, and actually applying for forgiveness with the taxpayer’s lender; and (ii) incurring eligible expenses and satisfying the other requirements under the CARES Act for forgiveness, but only expecting to apply for forgiveness in 2021. The IRS extended its rationale discussed above, asserting that IRC Section 265 applies to deny a deduction for expenses related to tax-exempt income regardless of when such tax-exempt income is received by the taxpayer.
At the same time, the IRS also issued Revenue Procedure 2020-51, which provides a safe harbor in the event the taxpayer’s “reasonable expectation” of PPP loan forgiveness turns out to incorrect. This could occur if the PPP loan is ultimately not forgiven or the taxpayer takes some irrevocable step preventing forgiveness, such as withdrawing a forgiveness application. In either case, if the event occurs prior to the filing of the taxpayer’s 2020 return, the taxpayer may take a deduction for the PPP Expenses on its 2020 return. If the event occurs after the filing of the taxpayer’s 2020 tax return, then the taxpayer may either (i) file an amended return for the 2020 tax year to take a deduction for the initially disallowed PPP expenses, or (ii) take a deduction for such expenses in the 2021 tax year. The guidance provides additional procedures if the taxpayer wants to claim the benefits of the safe harbor, including attaching a statement and relevant information to the affected tax return.
Taxpayers may wish to consult with their tax advisors to determine whether this new IRS guidance will affect their 2020 tax obligations.
* This article first appeared in The Journal Record on December 11, 2020, and is reproduced with permission from the publisher.