Client Alert: When Are Expenses Funded By A PPP Loan Eligible For Deduction?
The CARES Act & PPP
The Internal Revenue Service (the "IRS"), along with the U.S. Department of the Treasury, recently released further guidance clarifying when expenses funded by an unforgiven Paycheck Protection Program ("PPP") loan are eligible for deduction.
By way of background, Sections 1102 and 1106 of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") established the PPP as a new loan program administered by the U.S. Small Business Association. Pursuant to Section 1106 of the CARES Act, a PPP loan may be forgiven based on certain eligible expenses (e.g., payroll costs, rent payments, etc.) paid or incurred during the specified covered period. To many taxpayers’ dismay, in May of this year, the IRS released Notice 2020-32 which stipulated that no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP loan. The rationale behind such position is that allowing for such deductions would result in a double tax benefit. The IRS’s stance on this issue caused confusion amongst both businesses and tax professionals as it appeared inconsistent with Congressional intent given that amounts forgiven would be tax-free.
- Updated IRS Guidance On The PPP & Employee Retention Credit (May 12, 2020)
- COVID-19 Tax Developments (March 29, 2020)
Revenue Ruling 2020-27
Revenue Ruling 2020-27, issued on November 18, 2020, further confirms the IRS’s position on this matter and clarifies that if a taxpayer has a “reasonable expectation” that its PPP loan will be forgiven in the future, expenses related to and funded by the loan are not deductible. This is true irrespective of whether the taxpayer has applied for loan forgiveness or not.
The Revenue Ruling provides two examples to illustrate this principle. In the first situation, the taxpayer, a PPP loan recipient, paid certain eligible expenses and in November 2020 applied to its PPP lender for forgiveness on the basis of such eligible expenses. The taxpayer satisfied all requirements under the CARES Act for forgiveness. The lender does not inform the taxpayer as to whether the loan will be forgiven prior to the end of the year. In contrast, in the second situation, a taxpayer does not apply for loan forgiveness prior to the end of 2020, but taking into account its payment of eligible expenses it too satisfied all other requirements for forgiveness. The taxpayer in this second situation expects to apply to its lender for forgiveness at some point in 2021. The IRS concluded that the taxpayer in each situation has a reasonable expectation of reimbursement through loan forgiveness and therefore, deductions related to the payment of such eligible expenses are not permitted.
Revenue Procedure 2020-51
Revenue Procedure 2020-51, issued on November 19, 2020, provides a safe harbor allowing a taxpayer to claim a deduction in the taxpayer’s tax year beginning or ending in 2020 (“2020 tax year”) for certain otherwise deductible eligible expenses if the following conditions are met:
- The eligible expenses are paid or incurred during the 2020 tax year;
- The taxpayer receives a loan guaranteed under the PPP which, at the end of the taxpayer’s 2020 tax year, the taxpayer expects to be forgiven in a year after the 2020 tax year (a “subsequent tax year”); and
- In a subsequent tax year, the taxpayer’s request for forgiveness of the PPP loan is denied (either in whole or in part), or the taxpayer decides never to request forgiveness of the PPP loan.
The Revenue Procedure provides that eligible taxpayers (as described in the Revenue Procedure) satisfying the above requirements may deduct non-deducted eligible expenses on: (a) the taxpayer’s timely filed (including extensions) original income tax return or information return for the 2020 tax year; (b) an amended return or an administrative adjustment request for the 2020 tax year; or (c) in the case of a subsequent tax year, the taxpayer’s timely filed (including extensions) original income tax return or information return. Alternatively, eligible taxpayers may deduct the non-deducted eligible expenses in the year that the loan forgiveness is denied under general tax principles (assuming it does not otherwise elect to use the safe harbor under (a) or (b)).
Rev. Proc. 2020-51 also sets forth the safe harbor requirements and procedures, including the requirement for the taxpayer to attach a statement to the return in which the taxpayer deducts non-deducted eligible expense titled "Revenue Procedure 2020-51 Statement” and the details to be provided under such statement.
We recommend reviewing the following pandemic-related business and legal considerations we have been discussing with our clients:
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Contact us with any questions. We are here to assist you with evaluating when expenses funded by unforgiven PPP loans are eligible for deduction and other tax-related issues pertaining to your organization.