For plan advisors and small businesses that may have taken advantage of forgivable loans under the Paycheck Protection Program (PPP), newly released guidance by the IRS further digs in on its position regarding the deductibility of otherwise covered expenses. But that may not be the end of it.
If you’ll recall, the IRS advised in Notice 2020-32, released April 30, that it will not allow a tax deduction for an expense that is otherwise deductible under Internal Revenue Code Sections 162 and 163 if the payment of the expense results in forgiveness of a covered loan under the PPP.
The new guidance—in the form of a Revenue Procedure and Revenue Ruling—takes that one step further by addressing whether a PPP loan participant that paid or incurred certain otherwise deductible expenses can deduct those expenses whether the loan is forgiven or not.
The CARES Act established the PPP as a new loan program administered by the Small Business Administration that was designed to assist small businesses nationwide adversely impacted by the COVID–19 emergency to pay payroll costs and other covered expenses. Under the PPP, a covered loan may be forgiven if the proceeds are used for certain eligible expenses paid during the covered period, including payroll costs, interest on a covered mortgage obligation, any covered rent obligation and any covered utility payment. The covered period for making loans was initially the period beginning on Feb. 15, 2020 and ending on June 30, 2020, but was subsequently extended to Dec. 31, 2020.
Revenue Procedure 2020-51
Revenue Procedure (Rev. Proc.) 2020-51 provides a safe harbor for certain PPP loan participants whose loan forgiveness has been partially or fully denied, or who decide to forego requesting loan forgiveness. In general, the safe harbor allows a taxpayer to claim a deduction in the taxpayer’s 2020 tax year for certain otherwise deductible eligible expenses if:
- the eligible expenses are paid or incurred during the taxpayer’s 2020 tax year;
- the taxpayer receives a covered loan guaranteed under the PPP, which at the end of the taxpayer’s 2020 tax year the taxpayer expects to be forgiven in a tax year after the 2020 tax year (subsequent taxable year); and
- in a subsequent tax year, the taxpayer’s request for forgiveness of the covered loan is denied, in whole or in part, or the taxpayer decides never to request forgiveness of the covered loan.
As such, a taxpayer who meets the requirements spelled out in the revenue procedure may deduct nondeducted eligible expenses on the taxpayer’s timely filed, original income tax return or information return for the 2020 tax year (including extensions) or amended return or administrative adjustment request (AAR). Further, a taxpayer who satisfied the requirements could alternatively deduct the nondeducted eligible expenses for the subsequent tax year in the year that the loan forgiveness is denied.
Revenue Ruling 2020-27
By contrast, the IRS also released Revenue Ruling (Rev. Rul.) 2020-27, which holds that a taxpayer may not deduct eligible expenses in its 2020 tax year if, at the end of the 2020 tax year, the taxpayer has a reasonable expectation of their loan being forgiven, based on the eligible expenses it paid or accrued during the covered period. The holding still applies even if the PPP loan participant has not applied for forgiveness as of the end of the 2020 tax year, but intends to apply in the next tax year.
The revenue ruling provides two situations: one in which the taxpayer applies for loan forgiveness during 2020 and has a reasonable expectation that their loan will be forgiven by satisfying all the requirements for eligible expenses; and a second situation in which the taxpayer does not apply for loan forgiveness in 2020, but expects to apply for forgiveness in 2021 and has the same expectation of forgiveness.
In both situations, the IRS notes that both taxpayers each have a reasonable expectation of reimbursement and that deductions in 2020 are inappropriate, even if the taxpayer applied for forgiveness in 2021. “The fact that the tax-exempt income may not have been accrued or received by the end of the taxable year does not change this result because the disallowance applies whether or not any amount of tax-exempt income in the form of covered loan forgiveness and to which the eligible expenses are allocable is received or accrued,” the IRS states in the ruling.
In these instances, the IRS continues to point to Code Section 265, as it did in the earlier notice, to justify its reasoning for denying deductions for forgivable loans, noting that the purpose of that section is to prevent a double tax benefit.
Congressional Intent
Despite the IRS’ position, this issue may not be fully settled, however. When the IRS released Notice 2020-32 at the end of April, that caught the attention of the chairmen of the congressional tax-writing committees who expressed concern with the IRS’s interpretation. And this latest iteration by the IRS has rekindled the ire of Senate Finance Committee Chairman Charles Grassley (R-IA) and the committee’s ranking Democrat, Sen. Ron Wyden (D-OR).
“Small businesses need help maintaining their cash flow, not more strains on it,” Grassley and Wyden say in a joint statement. They “…encourage Treasury to reconsider its position on the deductibility of these expenses, and the timing of those deductions, to provide relief to the small businesses that need it most.”
The senators note that they will pursue clarification in year-end legislation that these covered expenses are deductible even if the PPP loan is forgiven.
In a May 5 letter to Treasury Secretary Steve Mnuchin, Grassley and Wyden, along with Rep. Richard Neal (D-MA), Chairman of the House Ways & Means Committee, argued that the position taken by the IRS was contrary to congressional intent. Various members of Congress subsequently introduced legislation to clarify that expenses paid with forgiven PPP loans remain tax-deductible and have vowed to fix the issue. With the stimulus negotiations stalled, the most likely possibility is to add a fix to the year-end spending bill for fiscal year 2021 that will be needed before the temporary fix expires on Dec. 11. The House did include a fix in the HEROES Act that passed in May, but that bill has been stymied in the delayed stimulus negotiations.
Both Rev. Proc. 2020-51 and Rev. Rul. 2020-27 will be in Internal Revenue Bulletin 2020-50, which will be published on Dec. 7, 2020.
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