As guidance in this area is being released regularly, we recommend you read all of our blogs on this subject. All the blogs in the Paycheck Protection Program series are here: Updates #1, #2, #3, #4, #5, #6, #7,#8,#9,#10, #11, #12,#13, #14, #15, #16, #17
On November 18, 2020, the IRS released Revenue Ruling 2020-27, amplifying Notice 2020-32, and simultaneously issued Revenue Procedure 2020-51. Both provide further clarity on deductibility of expenses paid with Payroll Protection Plan (PPP) funds and, not surprisingly, leave us with more unanswered questions.
Before we dive into the new guidance, it may help to understand the relevance of this issue. According to current guidance, any eligible expenses paid with PPP funds that are ultimately forgiven become non-deductible. This, in turn, increases a borrower’s taxable income and associated tax liabilities, reducing precious cash flow during challenging economic times. The result, as described below, is not equal for all for-profit PPP borrowers.
Revenue Ruling 2020-27 states the following:
“A taxpayer that received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.”
The Ruling provides two specific examples of calendar-year taxpayers who paid expenses with PPP funds during the 2020 tax year:
- The borrower applies for forgiveness in 2020 but the lender does not inform the borrower of their decision before year-end.
- The borrower plans to apply but decides not to apply for forgiveness until 2021.
In both circumstances, Treasury ruled that if the borrower reasonably expects to receive forgiveness, even if the taxpayer has not submitted or been informed that their forgiveness application has been accepted, the expenses paid with PPP funds become non-deductible in 2020.
What happens if I reasonably expect to receive forgiveness, disallow the expenses on my 2020 tax return, but later find out my loan isn’t fully forgiven?
Revenue Procedure 2020-51 provides guidance on when PPP expenses can be deducted. The answer depends upon whether or not the 2020 tax return has been filed.
In simple terms, if the 2020 tax return has not been filed, the taxpayer can deduct the expenses associated with the portion of the loan not forgiven. If the tax return has been filed, the taxpayer has the option to (1) amend their 2020 tax return or (2) deduct the expenses on their 2021 tax return. Should either situation arise, we recommend you read the Revenue Procedure in full as it outlines the procedure that must be filed to claim the associated expenditures.
For self-employed individuals, and partners in partnerships, who obtained PPP funds based upon “owner compensation replacement”(see PPP Update #5), the new guidance does not address if or how the owner compensation replacement becomes non-deductible. The current guidance is predicated on a normally deductible expense being paid with PPP funds, rendering the expense non-deductible. When “owner compensation replacement” is paid, there is no associated deductible expense to disallow.
How the expense disallowance is allocated amongst normally deductible expenses remains unclear. PPP funds are not required to be traced to specific expenses and instead the forgiveness applications request what qualified expenditures the borrower incurred. How the disallowed expenses are allocated could significantly impact other areas of the tax law, especially if the disallowance is allocated to wages, which is a key component of other tax provisions such as the qualified business income deduction or the research and development credit.
Assume a borrower receives a $100,000 PPP loan and submits a PPP forgiveness application with $120,000 of eligible expenses, including $80,000 of wages, $20,000 of utilities and $20,000 of rent. Assuming full forgiveness is attained on the $100,000 PPP loan, how is the $100,000 of non-deductible expenses allocated amongst the categories of eligible expenses incurred?
Where We Stand
Treasury has been consistent in its determination that expenses paid with PPP funds are non-deductible and has now clarified the associated timing around non-deductibility. Congress has signaled disagreement with Treasury’s position regarding deductibility of expense paid with PPP funds, including in recent comments about this new guidance, but continues to fail to act.
Treasury has sent a clear signal to Congress that if it wants this corrected, it must step up to the plate with a legislative fix. Until it does, the guidance outlined above is what we are left with. As is no surprise for 2020, taxpayers are left tax planning for the worst while hoping for the best.
We will continue providing PPP updates when significant and relevant information becomes available. If you have questions about how to navigate the PPP Forgiveness Application process, how to plan for non-deductible expenses related to PPP loan forgiveness, or how other CARES Act incentives may apply to your business, please call on us. You can stay up to date on PPP guidance and tax issues relating to the coronavirus at our COVID-19 Tax Resource Center.