The Paycheck Protection Program (PPP) created under the Coronavirus Aid, Relief, and Economic Security (CARES) Act provides loan funds to small businesses in order to help them pay eligible expenses (payroll costs, mortgage interest, rent, and utilities). These covered loans are to be fully forgiven and not to be treated as income to the loan recipients as long as the loans are used to pay eligible expenses.
While it was clear that a forgiven covered loan would not be treated as income if used to pay eligible expenses, what was previously not clear was the tax deductibility of the eligible expenses paid with the covered loan. IRS addressed this question with the issuance of IRS Notice 2020-32 on May 2, 2020. The notice specifically states that “…no deduction is allowed under the Internal Revenue Code (Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).” As a result, taxpayers are not permitted to receive both a tax-free income treatment on the forgiven loan and a tax deduction for the expenses paid with the loan funds.
A question that arose was whether a taxpayer may deduct certain eligible expenses that were paid and funded with a PPP loan in the tax year in which the expenses were paid or incurred if — at the end of such tax year — the taxpayer has either (1) not yet received final lender approval of forgiveness; or (2) not yet applied for loan forgiveness, with the knowledge that the payment of the eligible expenses would meet the requirements for loan forgiveness under the PPP guidelines.
New IRS Guidance
IRS has finally issued guidance on this issue. IRS Rev. Rul. 2020-27 provides that if taxpayers have a reasonable expectation that their PPP loans will be forgiven, then the eligible expenses paid with the loan funds in the 2020 tax year are not deductible even though the forgiveness has not yet been granted or the forgiveness application has not yet been submitted by the end of the tax year.
IRS also issued Rev. Proc. 2020-51, which addresses the situations where a taxpayer has paid eligible expenses with PPP loan funds in the 2020 tax year and either (1) expects the PPP loan to be forgiven but the forgiveness is denied in the subsequent year; or (2) decides not to request forgiveness of the PPP loan in the subsequent year.
In either of the two situations above, Rev. Proc. 2020-51 provides a safe harbor that allows the taxpayer to deduct some or all of the eligible expenses on:
- The taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for the 2020 tax year;
- An amended return or an Administrative Adjustment Request for the 2020 tax year, as applicable; or
- The taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for the subsequent tax year.
In order to utilize the safe harbor to deduct eligible expenses, the taxpayer must attach a statement to the filed return to disclose various information with regards to the date and amount of the covered loan, the date and total amount of covered loan forgiveness that was denied (or that the taxpayer decided to not request forgiveness), and the total amount of eligible expenses and non-deducted eligible expenses reported on the tax return.
To help you address your unique situation with a PPP loan and this new guidance, please contact us at firstname.lastname@example.org.