On November 18, 2020, the Internal Revenue Service (IRS) issued Revenue Ruling 2020-27 and Revenue Procedure 2020-51, which address the deductibility of certain business expenses paid with Paycheck Protection Program (PPP) loan funds. According to the Treasury Press Release, the new guidance is intended to clarify the tax treatment of expenses where a PPP loan has not been forgiven by the end of the year in which the loan was received.
As enacted in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the PPP offered loans of up to $10 million to many small businesses and nonprofit organizations. The loans were to be used for payroll and certain nonpayroll expenses and are generally forgivable if program rules are met.
Borrowers seeking forgiveness of PPP debt should understand how loan forgiveness impacts the deductibility of business expenses paid for with PPP loan funds.
On May 2, 2020, the IRS released Notice 2020-32, which explained that otherwise deductible expenses would not be deductible if paid utilizing a PPP loan that was later forgiven. In addition, PPP funds that were forgiven would be excluded from gross income as a “class of exempt income” under Section 265 of the Internal Revenue Code (IRC).
Given that most PPP borrowers will spend PPP funds in 2020 and receive PPP loan forgiveness, if any, in 2021, the question arose as to whether deductions could be taken for expenses paid with PPP funds in 2020 if those expenses had not yet been forgiven. The new IRS guidance is intended to address this question.
According to the Treasury Press Release and based on this new guidance:
- If the borrower applies for loan forgiveness in 2020 and reasonably expects that its loan will be forgiven, the borrower may not deduct otherwise deductible expenses paid for with PPP funds.
- If the borrower has not yet applied for loan forgiveness in 2020, but expects to apply for forgiveness in 2021 and reasonably expects that its loan will be forgiven, the borrower may not deduct otherwise deductible expenses paid for with PPP funds.
- For any deductible expenses paid with a PPP loan that the borrower expected to be forgiven, but it was not, or where a borrower decides not to request forgiveness, a taxpayer may qualify for a safe harbor procedure and be allowed to deduct the expenses.
Borrowers who qualify for the safe harbor procedure with respect to loan forgiveness that has been partially or fully denied will be permitted to claim the deductions on their 2020 original income tax return or information return (including extensions or on an amended return) or take a deduction in the tax year 2021, depending on the circumstances. For taxpayers who forego requesting loan forgiveness, the deductions may be claimed on the tax return for the taxable year in which the taxpayer makes that decision.
Upon release of Notice 2020-32 in May, several members of the Senate Finance Committee as well as the chairman of the House Ways & Means Committee stated that they believed the position of the IRS and Treasury was contrary to the intent of Congress in enacting the PPP and that businesses should be permitted to deduct business expenses paid for with PPP funds. Despite bipartisan support for new legislation on this issue, there is no certainty of a change to the current Treasury position. At this stage, taxpayers should follow IRS Notice 2020-32, as clarified by Revenue Ruling 2020-27 and Revenue Procedure 2020-51.