PPP Loan Forgiveness and Deductibility of Eligible Expenses
By: Richard Wilcock, richardw@squire.com
The CARES Act that was passed in March of 2020 established the Payroll Protection Program (PPP) to assist small businesses in covering the costs of payroll and other eligible expenses. As part of the PPP program, the Small Business Administration (SBA) is permitted to guarantee the full principal balance of the loan. Under the CARES Act the SBA may forgive the loan if the loan was used to cover payroll and other eligible expenses incurred during the “covered period” of either 8 or 24 weeks, and if certain other requirements are met.
CARES Act provisions stipulated that neither obtaining the loan nor subsequently getting it forgiven would be taxable events (despite the general tax law principle that forgiveness of debt is a taxable event). Unfortunately, the legislation did not address the deductibility of related expenses, and the IRS issued Notice 2020-32 on April 30, 2020, which indicated that deductions for expenses paid using PPP loan proceeds would be disallowed to the extent of forgiveness.
Despite that Notice, questions still remained, such as timing of loan forgiveness and its effect on the borrower’s tax. On November 18, the IRS issued Rev. Rul. 2020-27 and Rev. Proc. 2020-51 to provide further clarification.
Rev. Rul. 2020-27 covers the deductibility of payroll and other eligible expenses if the taxpayer reasonably expects to receive forgiveness for the PPP loan. Rev. Rul. 2020-27 states that if as of the end of 2020 the taxpayer reasonably expects to receive forgiveness for the PPP loan, then payroll and other eligible expenses incurred or paid for with the PPP loan will not be deductible by the taxpayer. For example, if the taxpayer receives a $50,000 PPP loan and expects the full $50,000 to be forgiven, $50,000 of payroll and other eligible expenses paid for by the PPP funds will not be deductible on the taxpayer’s 2020 tax return.
The IRS also issued Rev. Proc. 2020-51 to provide a safe harbor for taxpayers who expected to receive PPP loan forgiveness but were later denied. The Rev. Proc. 2020-51 safe harbor allows the taxpayer to deduct some or all of the payroll and other eligible expenses from the denied PPP loan forgiveness if certain conditions are met. Under this revenue procedure the taxpayer may deduct the payroll and other eligible expenses on a timely filed, including extension, original income tax return for the 2020 tax year. If the return has already been filed, the taxpayer can amend the 2020 tax return to pick up the eligible expenses or file an administrative adjustment request (AAR) under section 6227 of the Internal Revenue Code. If the original 2020 return has already been filed, the taxpayer can choose to deduct the payroll and other eligible expenses on a timely filed, including extensions tax return for the subsequent tax year if the taxpayer does not wish to file an amended 2020 tax return. A statement must be attached to the tax return titled (Revenue Procedure 2020-51) and include certain applicable information in order for a taxpayer to claim the safe harbor under Rev. Proc. 2020-51.
As a result of this new guidance, barring further legislative action by Congress, PPP loan recipients should not expect to deduct expenses paid for using PPP funds (to the extent of loan proceeds) on their 2020 tax returns. Please consult with a member of Squire’s PPP team to discuss these matters further!