column—entitled "IRS Doubles Down on Non-Deductibility of PPP Covered Expenses"—provides clarification on the non-deductibility of certain expenses paid with forgivable PPP loans.
In May, the Internal Revenue Service issued a controversial notice in which it stated that expenses funded by Paycheck Protection Program loans would not be deductible because the funding for such expenses is expected to be non-taxable; the CARES Act provides that PPP loans that are forgiven are excluded from gross income and will not result in cancellation of indebtedness income to the borrower. There was an outcry but to date, Congress has not acted to change the IRS’s decision. On November 18, despite the possibility of future COVID-related legislation, the IRS reiterated its stance through the issuance of a Revenue Ruling but provided a backup safe harbor if a PPP loan is not forgiven.
The Ruling states that a borrower who pays eligible expenses with funds from a PPP loan and reasonably expects the PPP loan to be forgiven may not deduct those expenses. This result is the same whether a borrower applies for forgiveness in 2020, or expects to apply for forgiveness in 2021. The Ruling optimistically presumes that if a taxpayer applies for forgiveness and reasonably expects such forgiveness, then the forgiveness is “foreseeable” and the deduction of the eligible expenses is not allowed.
The IRS, however, provides a route to deduction if forgiveness is denied or the application for forgiveness is withdrawn. In a Revenue Procedure, the IRS provides a safe harbor for deduction of eligible expenses in 2020 or a later year. If forgiveness of the PPP loan is denied, then the eligible expenses may be deducted, either on a timely filed (with extensions) tax return for 2020, an amended 2020 return, or a timely filed (with extensions) tax return for the year in which the forgiveness is denied (presumably 2021). The requirements for the safe harbor are (i) payment of eligible expenses in 2020 for which a deduction is not permitted, (ii) either submission by December 31, 2020 of an application for PPP loan forgiveness or an intention to submit an application for forgiveness in 2021, and (iii) either the requested forgiveness is denied or the borrower irrevocably decides not to seek forgiveness by, e.g., withdrawing an application for forgiveness. Obviously, the deduction of eligible expenses is limited to the principal amount of the PPP loan that is not forgiven. To apply the safe harbor, the borrower must include with its tax return which includes the deduction a “Revenue Procedure 2020-51 Statement” as described in the Revenue Procedure.
Based on current guidance, PPP loan borrowers with loans under $2,000,000 should have reasonable certainty regarding the likelihood of forgiveness of a PPP loan (absent breaches of the required certifications in the loan and forgiveness applications). For borrowers in excess of that amount (who should expect their forgiveness application to be reviewed more thoroughly by the SBA), forgiveness may be less certain (the draft questionnaires regarding “necessity” that the SBA covertly circulated for comment together with the lack of guidance on the substance of the review create such uncertainty), but taxpayers should not expect the IRS to accept that uncertainty as justification for taking the deduction before loan forgiveness is denied or the request withdrawn. Consequently, as with the decision regarding when to file for PPP loan forgiveness, whether to file a 2020 tax return early or defer filing to the extent permitted so as to incorporate any future guidance or rules (or action by Congress) is a more difficult decision than in other years.Revenue Ruling 2020-27: https://www.irs.gov/pub/irs-drop/rr-20-27.pdfRevenue Procedure 2020-51: https://www.irs.gov/pub/irs-drop/rp-20-51.pdf