On November 18, 2020, the Internal Revenue Service issued much-needed guidance under Rev Rule 2020-27, which addressed the timing of the deductibility of expenses paid with proceeds from a PPP loan. The IRS took the controversial position that these expenses are not deductible in the year the expenses are paid or accrued, even if the application for forgiveness was not filed before the taxpayer’s year-end or a decision had not yet been rendered on forgiveness by the lender.
To provide background, the CARES Act clearly stated that PPP loan proceeds were not considered taxable income. The IRS later issued guidance under Notice 2020-32, which stated that qualified expenses paid with PPP loan proceeds were not allowed to be deducted for tax reporting purposes. In effect, this will create a taxable situation for many taxpayers who received PPP loans and then anticipated PPP loan forgiveness. What was not addressed in the IRS’s initial guidance was the timing for when to treat these expenses as non-deductible, whether at the time the loan is forgiven or when the borrower incurred and paid for qualified expenses.
November 18’s guidance states that if a taxpayer “reasonably expects” loan forgiveness on the basis of the qualified PPP expenses being paid or accrued during the covered period, then these expenses are not deductible in 2020 – even if the application for forgiveness is not submitted before the end of 2020. The guidance does not further clarify the term “reasonably expects forgiveness” other than paying or incurring these qualifying expenses under the PPP loan forgiveness guidance.
Also unclear, and not addressed in the guidance, is the possibility that Congress will act and pass a law allowing these expenses to be deductible. There is bipartisan support for such a bill, and many are holding out hope that such legislation will be enacted.
Important Considerations for PPP Borrowers
Until legislation is passed that allows deductibility of expenses, borrowers should consider the following:
- Calculate fourth quarter estimates and anticipated 2020 final tax liability payments based on this new IRS guidance versus what would be applicable in the event that Congress acts to change the law.
- The state and local income tax treatment of the PPP loan expenses is still unclear.
- Adjust the cash forecast to include the payment of tax on the non-deductibility of these expenses.
- For businesses with loans over $2 million that will need to fill out a loan certification questionnaire and undergo an SBA audits, determine whether you can “reasonably expect” forgiveness on the loan, since more criteria will need to be evaluated to determine forgiveness.
- For businesses that had an ownership change during 2020, challenges arise between the previous ownership and the new ownership regarding the allocation of these non-deductible expenses due to the PPP loan’s expected forgiveness.
- Still unclear is how fiscal year companies will allocate these non-deductible expenses between fiscal years.
Safe-Harbor Guidance Offers a Choice for Some Taxpayers
To add to more layers of complexity, the IRS issued additional guidance on November 18 in the form of Rev Proc. 2020-51, which provides a safe harbor on the timing of the deduction for taxpayers in the following position:
- The eligible expenses are paid or incurred during the taxpayer’s 2020 tax year.
- The taxpayer receives a PPP loan and expects to be forgiven in a taxable year subsequent to the 2020 taxable year.
- In a subsequent taxable year, the taxpayer’s request for forgiveness of the covered loan is denied, in whole or in part, or the taxpayer decides never to request forgiveness of the PPP loan.
If all three criteria above are met, the taxpayer has a choice to:
- Deduct the expenses in 2020,
- Amend a return for the 2020 tax year, or
- Deduct the expenses in the subsequent taxable year (i.e., 2021).
Although this recent IRS guidance answers some of the outstanding questions surrounding the deductibility of PPP-related expenses, it serves as a painful reminder that Congress’s intention to treat the PPP loan as non-taxable still has not been fully realized. PPP borrowers will now need to manage their cash accordingly to address this controversial outcome.
We will continue to monitor this situation, and we will provide further information as it becomes available as part of our CARES Act accounting services. As always, if you have any questions about these or any other matters, please contact your Kreischer Miller relationship professional or any member of our team. For additional PPP-related news and resources, visit our COVID-19 Resource Center here.
Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect, or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.