Tax Deductibility of PPP Loan Expenses
To stay updated on this topic, review the January 2021 COVID-19 article.
Since the establishment of the Small Business Administration’s Paycheck Protection Program (PPP) earlier this year, there has been uncertainty regarding how the income and expenses related to these loans will be treated for tax purposes. Although early guidance stated that the forgiven loan would not be included in taxable income as cancellation of debt income, the treatment of expenses paid with these funds remained unclear. To address these concerns, the Internal Revenue Service and Treasury Department have released both a revenue procedure and a revenue ruling which clarify that businesses that have not been taxed on the proceeds of a forgiven PPP loan may not deduct expenses paid with such proceeds.
With the release of Revenue Ruling 2020-27, the IRS clarifies that no deduction will be allowed for an expense if the taxpayer reasonably expects the loan to be forgiven, regardless if that happens in 2020 or in a later year. This applies even if the taxpayer has not submitted an application for forgiveness at the end of the taxable year. Revenue Procedure 2020-51 adds a safe harbor for those taxpayers who are denied forgiveness or decide not to seek forgiveness. In this circumstance, a taxpayer may deduct those eligible expenses on a timely filed or extended 2020 tax return, an amended 2020 tax return, or on a timely filed or extended tax return for the subsequent year. If a taxpayer utilizes the safe harbor deduction, they must attach a statement to the respective tax return that includes the deduction. The IRS previously released guidance via Notice 2020-32 further clarifying that no deduction is allowed for any expense that is otherwise deductible if the payment of the expense results in forgiveness, and said forgiveness is excluded from gross income.
The nondeductibility of expenses paid with forgiven PPP Loan proceeds also applies to tax-exempt organizations with unrelated business income. Organizations must be careful to analyze expenses which are deducted against gross unrelated business income, and, if appropriate, allocate a portion of the nondeductible expenses. The IRS has so far declined to provide any further guidance regarding the specific application of Revenue Ruling 2020-27 to tax-exempt organizations.
The Treasury’s approach is not surprising, as their contention is that this treats all companies who received PPP loans fairly since they receive neither tax benefit or tax harm while not paying anything out of pocket. Leading members of the Senate Finance Committee Chuck Grassley (R – Iowa) and Ron Wyden (D – Oregon) disagree with this assertion and issued a joint statement that their original intent was for small businesses to receive the benefit of their deductions so as to not accelerate a taxpayer’s tax liability, and they explicitly included language in the CARES Act for this purpose. They have expressed a desire to address this issue in any end of year legislation and are pushing for the Treasury to reconsider its position. Simultaneously, the AICPA is pushing for a technical correction to the deductibility of expenses, as the current guidance results in the same net impact to the taxpayer as if the income from forgiveness was taxable. It remains to be seen if this will materialize in published guidance by the end of the year.
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This communication is intended to provide general information on COVID-19 relief measures as of the date of this communication and may reference information from reputable sources. Although our firm has made every reasonable effort to ensure that the information provided is accurate, we make no warranties, expressed or implied, on the information provided. As legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that may modify some of the provisions in this communication. Some of those modifications may be significant. As such, be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed.