IRS Rules Expenses Paid with PPP Loan Proceeds Are Not Deductible When There is Reasonable Expectation That Loan Will be Forgiven

As I reported in an earlier blog, in April, the IRS issued Notice 2032 https://www.irs.gov/pub/irs-drop/n-20-32.pdf stating their position that a deduction would not be allowed for expenses paid with the proceeds of a forgiven PPP loan. However, An IRS Notice is simply an indication that they intend to provide guidance to this effect in the future. It is not official guidance. During the last few months, several bills were introduced in Congress to put Congressional intent regarding deductibility into law. Congress did not act on any of these bills and no action is expected before year end. The combination of the IRS Notice and Congressional inaction has created uncertainty among borrowers and their advisors as to the whether business expenses paid for by PPP loan proceeds may be deducted, and if and when borrowers should apply for forgiveness.

On 11/19, the IRS released both Revenue Ruling 2020-27, https://www.irs.gov/pub/irs-drop/rr-20-27.pdf  and Revenue Procedure 2020-51, https://www.irs.gov/pub/irs-drop/rp-20-51.pdf, each of which is considered official guidance, controlling the deductibility of expenses paid for with PPP loan proceeds.

Revenue Ruling 2020-27

The Revenue Ruling makes it clear that if a taxpayer received a PPP loan and paid or incurred otherwise deductible expenses, those expenses are not deductible if the taxpayer reasonably expects to receive forgiveness of the loan. That applies whether or not they have applied for forgiveness by the end of the taxable year.

The Ruling provides two specific examples:

  • A borrower pays payroll and mortgage interest that are valid PPP expenditures. The borrower applies for forgiveness in November 2020 and satisfied all the requirements under the CARES Act to have it forgiven, but it doesn’t yet have an answer as to whether it will be forgiven.
  • A borrower paid the same type of expenses with its PPP loan, but expects to apply for forgiveness in 2021.

In both cases, the Ruling states that the business cannot deduct these business expenses. The businesses both have a “reasonable expectation” that the loans will be forgiven.

Revenue Procedure 2020-51

Revenue Procedure 2020-51 provides a safe harbor for taxpayers who do not deduct expenses in anticipation of the loan being forgiven and whose forgiveness is later denied in whole or in part or who later decide not to request forgiveness. Here are the rules that must be followed to claim these business deductions:

  • the eligible expenses are paid or incurred during the taxpayer’s 2020 tax year;
  • the taxpayer receives a PPP covered loan that, at the end of the taxpayer’s 2020 tax year, the taxpayer expects to be forgiven in a subsequent tax 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.

A taxpayer may be able to deduct some or all of the eligible expenses on:

  • the taxpayer’s timely, including extensions, original income tax return or information return, as applicable, for the 2020 tax year;
  • an amended return or an administrative adjustment request (AAR) under Code Sec. 6227 for the 2020 tax year, as applicable; or
  • the taxpayer’s timely, including extensions, original income tax return or information return, as applicable, for the subsequent tax year.

Applying the Safe Harbor

To apply the safe harbor, a taxpayer attaches a statement to the return on which the taxpayer deducts the expenses. The statement must be titled “Revenue Procedure 2020-51 Statement,” and must include:

  • the taxpayer’s name, address, and social security number or employer identification number;
  • a statement specifying whether the taxpayer is an eligible taxpayer under either section 3.01 or section 3.02 of Revenue Procedure 2020-51;
  • a statement that the taxpayer is applying section 4.01 or section 4.02 of Revenue Procedure 2020-51;
  • the amount and date of disbursement of the taxpayer’s covered PPP loan;
  • the total amount of covered loan forgiveness that the taxpayer was denied or decided to no longer seek;
  • the date the taxpayer was denied or decided to no longer seek covered loan forgiveness; and
  • the total amount of eligible expenses and non-deducted eligible expenses that are reported on the return.

Keep in mind nothing in the revenue procedure precludes the IRS from examining other issues relating to the claimed deductions for non-deducted eligible expenses, including the amount of the deduction and whether the taxpayer has substantiated the deduction claim. It also does not preclude the IRS from requesting additional information or documentation verifying any amounts described in the statement described in section 4.04.

What Should PPP Loan Recipients and Their Advisors Due Now?

It is still possible that Congress will pass legislation making the expenses deductible. It is highly unlikely that will happen in the lame duck session but is possible by the end of January in the new Congress. On the other hand, the IRS official has caused significant outcry from many in Congress, the AICPA, and many other influential organizations. This may Congress to act earlier, although most experts don’t expect that to happen.

The consensus among most experts and commentators is that PPP loan recipients should wait to file a forgiveness application. Most borrowers still are well within the forgiveness application window – 10 months from the end of the covered period of the loan. If there hasn’t been action in Congress before the tax filing deadlines in March and April 2021, most advisors are likely to recommend requesting an extension of time to file returns in the hope that Congress will pass legislation effectively overturning the IRS guidance before the extended due date.

By Mark Friedlich, Esq., CPA.

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Mark Friedlich

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