Further Guidance on the Deductibility of Expenditures
Paid Out of PPP Loan Proceeds
November 24, 2020
On November 18, 2020, the Internal Revenue Service issued additional guidance regarding the deductibility of expenditures that are paid from proceeds of a loan that was obtained under the Paycheck Protection Program (“PPP”). The PPP was established by the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), enacted on March 27, 2020.
We last discussed the PPP in our client alert of May 1, 2020. That client alert discussed Notice 2020-32, issued on April 30, 2020, where the Internal Revenue Service stated that no income tax deduction would be allowed for an expenditure to the extent the expenditure results in forgiveness of a PPP loan. Under the terms of the CARES Act, forgiveness of all or a portion of a PPP loan does not result in income to the borrowing taxpayer. According to the Internal Revenue Service, allowing a PPP loan recipient to deduct expenses paid with PPP loan proceeds and also not be taxable on the forgiveness of the loan would result in a double tax benefit. The guidance issued on November 18, 2020 clarifies that a taxpayer that has paid or incurred deductible expenses outlined in the CARES Act with PPP loan proceeds may not deduct those expenses in the taxable year in which the expenses were paid or incurred to the extent that, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the PPP loan.
The first piece of guidance issued last week, Revenue Ruling 2020-27, sets forth two hypothetical scenarios. In the first scenario, as of the end of 2020, a calendar-year taxpayer has applied for forgiveness of the PPP loan and has satisfied all of the requirements for forgiveness; however, the lender has not yet informed the taxpayer whether or not the loan will be forgiven. In the second scenario, also as of the end of 2020, a calendar-year taxpayer has satisfied all of the requirements for forgiveness, has not yet applied for forgiveness, but does expect to apply for and obtain forgiveness in 2021. The Revenue Ruling concludes that neither taxpayer could deduct these expenses in 2020 because, as of the end of 2020, both taxpayers reasonably expect to be reimbursed for these expenses through PPP loan forgiveness.
The second piece of guidance issued last week, Revenue Procedure 2020-51, provides a safe harbor that allows a taxpayer to claim a deduction for eligible expenses if forgiveness of the taxpayer’s PPP loan is fully or partially denied or if the taxpayer decides not to seek forgiveness for some or all of the PPP loan. To meet the safe harbor, the taxpayer must: (1) have paid or incurred eligible expenses in the 2020 taxable year for which no 2020 deduction was permitted because as of the end of 2020 the taxpayer reasonably expected to receive loan forgiveness; and (2) have submitted by the end of the 2020 taxable year (or must intend to submit) an application for PPP loan forgiveness to the lender. The taxpayer must either be denied PPP loan forgiveness or withdraw its application before claiming a deduction under the safe harbor. In order to claim the benefits of this safe harbor, the taxpayer must submit a statement to the Internal Revenue Service outlining how it meets the requirements set forth in Revenue Procedure 2020-51. If the safe harbor is met, a taxpayer may be able to deduct some or all of the eligible expenses on (1) the taxpayer’s timely filed original income tax return for the 2020 taxable year, (2) an amended return or an administrative adjustment request for the 2020 taxable year, or (3) the taxpayer’s timely filed original income tax return or information return for the subsequent taxable year in which the taxpayer decides not to seek PPP loan forgiveness or the loan forgiveness is denied.
According to a statement by Treasury Secretary Steven Mnuchin on November 18, 2020, the guidance issued is intended to provide taxpayers with greater clarity and flexibility, while encouraging borrowers to file for PPP loan forgiveness as quickly as possible. While it is possible that Congress could attempt to change the position of the Internal Revenue Service through legislation, it is unclear how or when such a change could happen.
We will keep you updated as we learn more about the treatment of PPP loans, but please do not hesitate to contact us directly if you have any questions or would like to discuss these issues in more detail.