On November 18th, the IRS issued much-awaited guidance clarifying their position regarding the taxability of Payroll Protection Program (PPP) loan forgiveness.
As we approach the end of 2020, many taxpayers and tax practitioners have been wondering whether or not expenses that were incurred in 2020 and paid with Payroll Protection Program (PPP) proceeds would be deductible in the current year if the PPP loan wasn’t forgiven until next year. On November 18, the IRS issued guidance in the form of Revenue Procedure 2020-51 and Revenue Ruling 2020-27 that clarified their position.
What do these revenue procedures clarify?
Generally, the expenses (payroll, rent, utilities, and mortgage interest) used to apply for PPP forgiveness become nondeductible expenses in the year they were incurred regardless of whether the business has been notified of forgiveness by year-end. Since the taxpayer used the loan proceeds for qualifying expenses and either has submitted or intends to submit a forgiveness application, they have a reasonable expectation of reimbursement of the expenses, i.e. loan forgiveness. Since the expectation of forgiveness is reasonable, rather than being unforeseeable, a tax deduction for the expenses is considered disallowed on the 2020 income tax return.
Is this a significant change to what we previously heard from the IRS in April?
No, these revenue procedures merely give updated guidance to taxpayers on the timing of when the expenses are considered nondeductible and do not change the previous guidance that they are nondeductible. Many professionals and business owners still have hope that Congress will pass a bill reversing the non-deductible nature of the expenses previously issued by the IRS. There have been numerous bills introduced, but little progress has been made since May 2020.
What happens if a taxpayer has a reasonable expectation of loan forgiveness in 2020 only to find out in 2021 that their loan wasn’t forgiven?
Revenue Procedure 2020-51 sets forth a safe harbor which allows deduction of qualified expenses on the taxpayer’s 2020 or 2021 income tax return in the event that a taxpayer had a reasonable expectation of PPP loan forgiveness as of 12/31/2020 but subsequently discovers that their request for loan forgiveness is denied. Refer to the revenue procedure for detailed guidance if there is a possibility your PPP loan may not be forgiven (or partially forgiven).
Background on the PPP loan and Guidance from the IRS in April 2020
Earlier this year, in an effort to help taxpayers combat the effects of the COVID-19 pandemic, Congress passed the CARES Act which included SBA authorized loans to be issued to small businesses throughout the United States. If taxpayers obtained a PPP loan and used the proceeds for these qualified expenses (payroll, rent, utilities, and mortgage interest) during their covered period (8 weeks and subsequently increased to 24 weeks), they could apply for loan forgiveness. Further, if the loan was forgiven, the proceeds would be considered non-taxable income to the taxpayer. However, months later the IRS released Notice 2020-32, concluding that any expenses used to apply for forgiveness would be nondeductible expenses. Essentially, the PPP loan forgiveness becomes taxable income.
What do we still not know?
This guidance does not address the order in which the eligible expenses (payroll, rent, utilities, and mortgage interest) lose the ability to be deducted. Further, the guidance does not address other matters that could have significant tax implications including, but not limited to, the impact on the following:
Qualified business income deduction (Section 199A);
Research and development credits; and
Interest deduction limitation (Section 163(j)).
Additionally, many are still holding hope that Congress passes a bill reversing the IRS guidance that the expenses are nondeductible for tax purposes.
In summary, what does this mean?
The IRS appears to believe that any expenses incurred by a taxpayer in connection with potential loan forgiveness should be disallowed on the taxpayer’s 2020 income tax return. While this wasn’t the answer that most were hoping for, it does provide us with the position that we can expect the IRS to take on this matter.