11.23.20 | Client Alert
Last week, the IRS issued much anticipated guidance on the deductibility of business expenses claimed, or to be claimed, as amounts supporting loan forgiveness on a Paycheck Protection Program (“PPP”) loan forgiveness application. The guidance was released in two parts, as a Revenue Ruling (Rev Rul 2020-27) and as a Revenue Procedure (Rev Proc 2020-51). The Revenue Ruling provides guidance on when PPP related expenses become non-deductible for tax purposes, while the Revenue Procedure provides a safe harbor for deducting those expenses, if in a subsequent year they are ultimately not forgiven.
Revenue Ruling 2020-27 reinforces Notice 2020-32, issued this past May, which disallows a deduction for expenses that are included in a company’s PPP loan forgiveness amount. The ruling then goes a step further and provides that taxpayers will lose their deduction for expenses incurred in 2020 so long as they have a reasonable expectation of forgiveness at the end of the year. The IRS provides two scenarios, where in both cases the taxpayer is unable to deduct costs incurred during 2020 on a 2020 tax return. In the first scenario, the taxpayer submits its PPP loan forgiveness application before the end of 2020, but the lender does not inform them whether the loan will be forgiven before the end of the year. In the second scenario, the taxpayer has not yet submitted its loan forgiveness application before the end of the year. In both cases, the IRS reasons that the amount of reimbursement of the PPP loan is foreseeable and therefore the taxpayer has a reasonable expectation of what their forgiveness amount will be. In the second scenario, even though the taxpayer has yet to submit a loan forgiveness application, the IRS asserts that because the loan covered period has expired, the taxpayer has all information necessary to be able to determine the amount of their loan that will be forgiven and therefore, the associated expenses are not deductible in 2020.
While the position in Revenue Ruling 2020-27 is not unexpected, it is not good news for PPP borrowers hoping for a reversal of the IRS’s position of nondeducibility or for the ability to delay nondeducibility to 2021 by applying for forgiveness at a later time. However, this may not be the last word as leading members of the Senate Finance Committee from both parties have already issued a statement disagreeing with the IRS doubling down on its position. Other members of Congress have publicly expressed their frustration with the IRS’ stance as well. Therefore, it is possible that Congress will pass legislation that would allow the deduction if the opportunity arises with year end legislation.
The IRS does provide a break for PPP borrowers in Revenue Procedure 2020-51. Here, the IRS provides a safe harbor for taxpayers to be able to claim deductions for amounts where they had a reasonable expectation of forgiveness at the end of 2020, but ultimately did not have their entire loan forgiven.
The safe harbor applies if a taxpayer has a PPP loan and, as of the end of 2020, expects it to be forgiven in the subsequent taxable year, but in 2021 the forgiveness request is denied, in whole or in part, or the taxpayer decides never to request forgiveness of the PPP loan. A taxpayer falling into this safe harbor may be able to deduct some or all of the eligible expenses that it originally expected to be forgiven in one of three ways:
- A 2020 timely filed tax return, including extensions;
- An amended return or Administrative Adjustment Request (AAR), as applicable to the taxpayer; or,
- The taxpayer’s timely filed tax return for the subsequent year, including extensions.
As a result, PPP borrowers are now provided a safety net with some flexibility in the case where they do not receive the amount of loan forgiveness that they expected as of the end of their 2020 tax year. As always, we will continue to monitor all guidance that the IRS and Small Business Administration release relating to PPP loan forgiveness. We expect that there may be additional guidance forthcoming on topics such as the allocation of non-deductible PPP expenses between expense categories and the interplay between wages for PPP and 199A.
For more information on this topic or any other matter related to the COVID-19 pandemic, please contact your Berdon advisor and visit Berdon’s COVID-19 Information Center.
Berdon LLP New York Accountants