Has your business been waiting to apply for Paycheck Protection Program (PPP) loan forgiveness because of uncertainty surrounding the deductibility of PPP expenses?
The recent IRS Revenue Ruling (2020-27) provides guidance on this issue.
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was passed by Congress in March 2020. The CARES Act established the PPP loan program to assist small businesses that were adversely impacted by the COVID-19 pandemic. Businesses that use PPP loans for qualified expenses, such as payroll costs, interest on a mortgage, utility payments, and rent, are eligible to apply for loan forgiveness. The CARES Act clearly states that borrowers can exclude forgiven PPP loans from their taxable income. However, it is silent on the tax treatment of expenses paid with the loan proceeds.
Shortly after the CARES Act was enacted, the IRS issued Notice 2020-32. This notice explained that “no deduction is allowed under the Internal Revenue Code for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan.” In simpler terms: deductions for expenses paid for with forgiven PPP loans are not allowed.
The question of whether or not borrowers should be allowed to take deductions for expenses associated with forgiven PPP loans has become highly debated.
Following the IRS’s announcement that the deduction of such expenses would not be allowed, a large group of over 170 business and trade organizations urged Congress to make a technical correction to the CARES Act to address the issue. A number of Congressional leaders also expressed dissatisfaction with the IRS’s interpretation. A bipartisan Senate bill, the Small Business Expense Protection Act, was introduced in May and sought to clarify that expenses paid for with forgiven PPP loans are tax deductible. A similar House bill was also introduced. However, both bills and all coronavirus stimulus negotiations have remained stalled in Congress.
The Question of Timing:
While IRS notice 2020-32 addressed the deductibility of business expenses associated with forgiven PPP loans generally, it did not clarify the potential impact of the timing of the application. For example, what would happen if a borrower received his PPP loan in 2020, spent the loan on eligible expenses in 2020, but did not receive approval of his forgiveness application until 2021? Could he deduct the 2020 expenses because the loan had not yet been forgiven?
This question left many business owners, including a number of our clients, scratching their heads, not sure how to approach their year-end planning and forecasting for 2021.
Where we are now:
The IRS has released a new Revenue Ruling that answers the question about what impact the timing of PPP loan forgiveness has on associated expense deductibility.
Revenue Ruling 2020-27 provides guidance by way of two hypothetical taxpayers – Taxpayer A and Taxpayer B.
Taxpayer A receives his PPP loan in 2020, paid eligible expenses in 2020, applies for forgiveness in 2020, satisfies all requirements for forgiveness, but his lender does not inform him whether the loan will be forgiven before the end of 2020.
Taxpayer B shares the same fact pattern with Taxpayer A, except that she does not apply for loan forgiveness until 2021.
According to the IRS, A and B both knew the amount of their eligible expenses before the end of 2020 and it was foreseeable, before the end of 2020, that they were going to receive loan forgiveness, therefore, when the application was actually filed is not relevant.
We now have a definitive answer: eligible expenses paid for with PPP loans are not deductible if the borrower “reasonably expects” to receive loan forgiveness, regardless of when the forgiveness actually occurs.
While some may be dismayed by this recent development, there is always some value in certainty. This new guidance will allow business owners to move forward with their year-end planning and to submit PPP forgiveness applications that they have been delaying.
In these rapidly changing times, fast updates are essential to keeping your business and estate planning up to date and working!