IRS Releases Much-Awaited Guidance on PPP-Loan-Related Expenses, But More is Still Needed
December 1, 2020
By Magnolia M. Movido and William A. Kastin
CAUTION: Some of the analysis below is no longer accurate as a result of the enactment of Section 276(a) of the COVID-related Tax Relief Act of 2020 (“Act”), enacted as Subtitle B of Title II of division N of the Consolidated Appropriations Act of 2021, signed into law on December 27, 2020. The IRS, on January 6, 2021, adopted the provisions of the Act through Revenue Ruling 2021-2 which obsoletes Notice 2020-32 and Rev. Rul. 2020-27. Please see New COVID-19 Relief Bill Adds PPP ‘Second Draw’ Loans and Modifications to Original PPP which references the deductibility of expenses paid or incurred by businessowners who participated in the PPP.
On November 18, 2020, the Internal Revenue Service ("IRS") clarified its stance on the deductibility of expenses paid or incurred by businessowners who participated in the Paycheck Protection Program (“PPP”) by issuing Revenue Ruling (“Rev. Rul.”) 2020-27 and Revenue Procedure (“Rev. Proc.”) 2020-51.
By way of background, the borrower of a PPP loan may use the borrowed proceeds to pay its business expenses. Subject to various additional rules, to the extent the PPP loan was used to pay certain “eligible expenses” (e.g., (i) payroll costs, (ii) certain employee benefits relating to healthcare, (iii) interest on mortgage and certain other obligations, (iv) rent, and (v) utilities) during either the 8- or 24-week period beginning with the loan origination date (sometimes referred to as the “covered period”), such portion of the PPP loan was eligible for forgiveness – meaning that the borrower would not have to pay it back. Additionally, and of great interest to many PPP borrowers, Section 1106(i) of the CARES Act provides that any amount that would be includible in gross income as a result of such forgiveness (e.g., as income from the discharge of indebtedness or otherwise) shall be excluded from gross income. In short, if the PPP loan was used to pay eligible expenses during the covered period, then the borrower could apply for forgiveness, and if the PPP loan was forgiven, then the borrower would not have to recognize the amount forgiven as income.
Earlier this year, in Notice 2020-32, the IRS announced that no deduction would be allowed for an expense that is otherwise deductible if the payment of the expense results in forgiveness, and the forgiven loan amount is excluded from income pursuant to the CARES Act.1
II. Revenue Ruling 2020-27
Rev. Rul. 2020-27 contemplates two scenarios. In the first scenario, the taxpayer used its PPP loan to pay eligible expenses during the covered period. In November, 2020, the borrower applied for PPP loan forgiveness and satisfied all the requirements for the application. The borrower was not informed whether the PPP loan would be forgiven before end of 2020. In the second scenario, the borrower expects to apply for, and receive, loan forgiveness in 2021. Importantly, in both scenarios, the borrower has a reasonable expectation that the PPP loan will be forgiven. The Revenue Ruling concludes that in both scenarios the borrower may not deduct the eligible expenses.
III. Rev. Proc 2020-51
Where Rev. Rul. 2020-27 addresses situations in which a PPP borrower may not deduct an expense, Rev. Proc. 2020-51 provides a safe harbor pursuant to which a PPP borrower may deduct an expense. To qualify under the safe harbor rules: (i) the eligible expenses must be paid during the borrower’s 2020 tax year, (ii) the taxpayer expects the PPP loan to be forgiven in 2021 (or thereafter), and (iii) the application for loan forgiveness is either never submitted or denied (in either case, in whole or in part).
If the requirements of the safe harbor are satisfied, then the borrower may deduct the eligible expenses on (i) the taxpayer’s timely filed, including extensions, tax return for its 2020 tax year, (ii) an amended tax return (or similar administrative adjustment request) for its 2020 tax year, or (iii) the taxpayer’s timely filed, including extensions, tax return for its 2021 tax year.
IV. Additional Thoughts
Although this most recent guidance from the IRS is both helpful and welcome, it still leaves open certain questions. For example, if the PPP loan is forgiven and the deduction is disallowed, it is unclear whether (i) a deduction of the eligible expenses is disallowed, or (ii) a deduction is disallowed in an amount equal to the PPP proceeds used to pay eligible expenses.
Rev. Proc. 2020-27 appears to answer this question by specifically providing that the deduction is disallowed for the borrower’s eligible expenses. However, inasmuch as Rev. Proc. 2020-51 allows for a deduction in an amount equal to the eligible expenses on the borrower’s 2021 tax return, the issue remains unclear. Perhaps these two rulings are not entirely inconsistent, i.e., if the deduction is denied under Rev. Proc. 2020-27, then the denial is for the eligible expenses, but if the deduction is allowed under Rev. Proc. 2020-51, then the deduction is allowed for an amount equal to the PPP proceeds used to pay the eligible expenses.
This is a continuously evolving area of law in which subsequent clarifications have arguably undermined previously issued guidance. While taxpayers can be thankful the 2020 tax year is coming to a close, their tax advisors should be mindful of how to report certain transactions that have taken place throughout the year.
- The manner in which these developments came about was fairly controversial. Initially some believed that Congress intended PPP borrowers who paid eligible expenses during the covered period to benefit from both (i) the exemption of income and (ii) a corresponding deduction. The IRS guidance disallowed the latter. To fuel the controversy, in May, 2020, Senate Bill 3612 was introduced and provided that receipt of PPP loan forgiveness should not cause the denial of the deduction of the business expenses paid from the PPP loan funds. However, to this day, the bill has not passed, meaning that IRS Notice 2020-32 continues to remain in effect.
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