The IRS recently released Revenue Ruling (Rev. Rul.) 2020-27 and Revenue Procedure (Rev. Proc.) 2020-51[i] officially announcing the rules for deducting expenses funded with Paycheck Protection Loan (PPL) funds.
In May, the IRS issued Notice 2020-32 stating that “no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of the covered loan.” This means that a forgiven loan that was excluded from income was becoming taxable through another means. These loan proceeds were tax-free, but the expenses funded by the loan proceeds were not tax-deductible. Effectively, this increases a taxpayer’s net business income – not the answer taxpayers nor Congress expected.
In Notice 2020-32, the IRS stated that “no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of the covered loan.” From this it seemed that in order for expenses not to be deductible, a PPL actually had to be forgiven. Furthermore, if the expenditure occurred in 2020 and forgiveness in 2021, the expenses would be deductible in 2020, and the loan forgiveness income would be reported in 2021. This would provide taxpayers with an opportunity to potentially increase a 2020 net operating loss which could be carried back to recover prior years’ taxes paid at a higher rate.
Things often are not as they appear. In the new guidance, Rev. Rul. 2020-27 states that if a PPL borrower has a “reasonable expectation” the loan will be forgiven, deducting PPL-funded expenses is forbidden. Even if loan forgiveness has not actually occurred, borrowers cannot deduct PPL-funded expenses if the borrower reasonably believes the loan will be forgiven.
In an example provided in Rev. Rul. 2020-27, a taxpayer by the end of 2020 has yet to apply for loan forgiveness but has satisfied the requirements under the CARES Act (i.e.: was eligible for the loan and spent it on eligible expenses) and expects to apply for forgiveness in 2021. Consequently, at the end of 2020, the taxpayer knew the amount of eligible expenses and has a reasonable expectation that the PPL that funded expenses would be forgiven. Therefore, the forgiveness of the loan is foreseeable, and the expenses funded by it are not deductible.
Rev. Proc. 2020-51 provides a safe harbor which allows taxpayers to claim a 2020 deduction of PPL-funded expenses if:
- the eligible expenses are paid or incurred during the taxpayer’s 2020 taxable year;
- the taxpayer received a PPL, and at the end of the year the taxpayer expects the loan to be forgiven in a taxable year after 2020; and
- in that subsequent taxable year, the taxpayer’s request for forgiveness is denied or the taxpayer never requests forgiveness.
Frankly, this safe harbor seems unnecessary because, if forgiveness is denied or not applied for, the taxpayer would simply deduct the expenses on a timely filed or amended 2020 return.
Both Rev. Rul. 2020-27 and Rev. Proc. 2020-51 clarify the IRS’s position about overall expense non-deductibility. However, this guidance creates additional questions. Particularly, does a borrower of more than $2 million that has to complete an SBA loan necessity form but meets all the CARES Act requirements have a reasonable expectation that its loan will be forgiven? Also, how will taxpayers report the expense reduction? Until these questions are answered, taxpayers cannot accurately estimate their 2020 federal income tax liabilities.
The deductibility of PPL-funded expenses is an issue that frustrates us and you alike. I hope Congress resolves this legislatively before April 15th. In the meantime, read our 2020 Income Tax Recommendations for PPP Borrowers for more information on how to navigate this unusual year-end and upcoming tax filing season.
[i] A Revenue Ruling is the IRS’s official interpretation of the Internal Revenue Code, related statutes, tax, treaties and regulations. It is substantial authority with respect to the issue addressed. A Revenue Procedure is the IRS’s official statement of a procedure that affects the rights or duties of taxpayers or other members of the public. A Revenue Ruling states the IRS’ position and a Revenue Procedure states instructions on how to implement the IRS’s position. A Notice is the IRS’s public pronouncement of its interpretation of the tax code and other provisions of the law. A notice is not substantial authority.