Update: PPP Loan Forgiveness and Expense Deductibility

The Internal Revenue Service and Treasury Department issued long-awaited guidance last week that clarified a number of uncertainties regarding the timing of deductibility of expenses relating to Paycheck Protection Program (PPP) loans.

If a PPP loan recipient has some or all of the loan forgiven by the end of the 2020 tax year or can reasonably expect forgiveness will occur after 2020, then the qualifying expenses leading to PPP loan forgiveness are not tax deductible, regardless of when forgiveness occurs.  This is the official IRS position unless and until Congress enacts a law declaring these expenses to be tax deductible.

Background: The CARES Act was enacted in March 2020, creating federal PPP loans to provide financial support to businesses experiencing hardship from the coronavirus pandemic. As an incentive to minimize reduction in workforce and keep people employed, the law provided for forgiveness of PPP loans based on specified spending guidelines and maintaining employee headcount. Furthermore, income that resulted from forgiveness of PPP loans was deemed non-taxable under the CARES Act.

About a month after the CARES Act was enacted, the IRS published its opinion that a deduction for expenses directly correlated with PPP loan forgiveness was not allowed (Notice 2020-32). Certain parts of the tax code, regulations, and key court cases were pointed out by the IRS in support of its position. Congress responded quickly, stating its intent that qualifying expenses using PPP loan funds should remain tax deductible. Unfortunately for taxpayers, this was not written into the CARES Act, so it never became law. Until a new law is passed, expenses underlying PPP loan forgiveness are not tax deductible.

The IRS did not clarify, however, whether these expenses could still be claimed as tax deductible in 2020 even if PPP loan forgiveness did not occur by the end of the year. The timing of loan forgiveness came into question among taxpayers and tax practitioners without any guidance from the IRS. It was unclear whether a company, that obtained a PPP loan, spent it on qualifying expenses in 2020, and did not obtain forgiveness from the lender until 2021, should treat the expenses as non-deductible in 2020. In other words, the point at which forgiveness occurs was the key event in determining the timing of expense deductibility. Through the issuance of two documents, Revenue Ruling 2020-27 and Revenue Procedure 2020-51, the IRS has finally provided clearer guidance on this issue.

Revenue Ruling 2020-27: This IRS ruling, issued on November 18, 2020, provided the wording needed to clarify the questions regarding timing. Two examples of taxpayers were explained. One example outlines a taxpayer that received a PPP loan in 2020 and applied for forgiveness in November 2020, but did not hear back from the lender by December 31, 2020. In the second example, the taxpayer also received a PPP loan in 2020 but did not apply for loan forgiveness until 2021. In both cases, the taxpayers knew the amount of qualified expenses and, therefore, had a reasonable expectation of the amount of loan forgiveness that would occur. Because of this, the IRS says the taxpayers cannot deduct the expenses incurred in 2020 that are considered eligible for loan forgiveness.

Revenue Procedure 2020-51: Also issued on November 18, 2020, the IRS provides guidance by allowing deductions for PPP-related expenses in 2020 in situations where PPP loans are not forgiven in part or in full. Referred to as a safe harbor, the IRS lists three conditions where the PPP expenses will be allowed: (1) eligible expenses are paid or incurred in the taxpayer’s 2020 tax year, (2) a PPP loan is obtained in 2020 that is expected to be forgiven, and (3) after 2020, the lender denies forgiveness or the taxpayer decides to no longer request forgiveness. If these three conditions are met, then the PPP-related expenses are deductible on the taxpayer’s 2020 tax return or a subsequent year tax return. A statement explaining eligibility, year of deduction, and a description of the loan and underlying expenses is required to be attached to the tax return.

Conclusion: We are in a situation where expenses that give rise to PPP loan forgiveness are currently not tax deductible, even if forgiveness is not yet applied for or achieved by year end. It is prudent, therefore, to plan your current and future tax liabilities with this in mind. In addition, if you haven’t yet applied for PPP loan forgiveness due to waiting for clarity on the tax deductibility issue, it may be time now to apply. There are other possible factors to consider before applying in order to maximize forgiveness, so be sure to check those as well. Finally, we advise that the tax deductibility situation could change if the tax law changes. For this reason, we recommend not rushing to file your 2020 tax return, and consider an extension, until the tax deduction situation has been addressed by Congress. Your advisors at Santora CPA Group should be consulted on all of these matters.

At Santora CPA Group, our professionals continue to monitor the complex financial and tax regulatory changes related to the coronavirus pandemic that have evolved since March 2020. We are well-positioned to help clients and associates understand the opportunities and requirements of these changes, and counsel them to help make informed, sound decisions.

If you need more information or want your tax situation reviewed by us, please don’t hesitate to contact our office at (302) 737-6200.

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