IRS Addresses Tax Treatment of PPP Loan Forgiveness

Since the issuance of IRS Notice 2020-32 , which provided that expenses reimbursed by a forgiven Paycheck Protection Program (“PPP”) loan are non-deductible, the obvious next question is: What happens if the forgiveness, in whole or in part, is not received by the end of the taxable year?  This is particularly relevant as we approach the end of 2020.

With Rev. Rul. 2020-27 and Rev. Proc. 2020-51, the IRS addresses that issue directly.

Rev. Rul. 2020-27

In Rev. Rul. 2020-27, the IRS affirms the view expressed in Notice 2020-32 that the expenses reimbursed by a forgiven PPP loan are non-deductible, notwithstanding comments by leading Congressional taxwriters that such position is inconsistent with the PPP’s intent.  Further, the Revenue Ruling holds that a taxpayer that received a PPP loan and paid or incurred eligible PPP expenses may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer “reasonably expects” to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year. 

In reaching this conclusion, the Revenue Ruling reviews the forgiveness process.  Namely, the CARES Act and supporting loan forgiveness application procedures published by the SBA provide covered loan recipients with “clear and readily accessible guidance to apply for and receive covered loan forgiveness.”  Under these procedures, each taxpayer calculates the amount of its covered loan forgiveness on the basis of the eligible expenses paid or accrued in the covered period and submits a completed form and supporting documentation to their covered loan lender.  Within 60 days of receipt of an application for forgiveness, the covered loan lender must issue a decision regarding the forgiveness application.  Accordingly, the Revenue Ruling concludes that the loan recipient’s eligible expenses are not deductible “because there is a reasonable expectation of reimbursement.” The reimbursement, in the form of covered loan forgiveness, is “foreseeable.”

In the alternative, the Revenue Ruling, consistent with Notice 2020-32, applies an IRC Sec. 265(a)(1) [Expenses Relating to Tax-Exempt Income] analysis – that IRC Sec. 265(a)(1) disallows any amount of eligible PPP expenses otherwise deductible to the extent the payment of such eligible expenses is allocable to “tax-exempt” income in the form of the reasonably expected loan forgiveness (which by statute is not includible in gross income).  The fact that the tax-exempt income may not have been accrued or received by the end of the taxable year, according to the Revenue Ruling, does not change the result because the “disallowance applies whether or not any amount of tax-exempt income in the form of covered loan forgiveness and to which the eligible expenses are allocable is received or accrued.”

Rev. Proc. 2020-51

Rev. Proc. 2020-51 provides a “safe harbor” allowing a taxpayer to claim a deduction in the taxpayer’s taxable year beginning or ending in 2020 (“2020 taxable year”) for otherwise deductible eligible expenses under the PPP if –

• The taxpayer paid or incurred eligible expenses in the 2020 taxable year for which no deduction is permitted because at the end of the 2020 taxable year the taxpayer reasonably expects to receive forgiveness of the covered loan based on those eligible expenses (“non-deducted eligible expenses”);
• The taxpayer submitted before the end of 2020 taxable year, or as of the end of the 2020 taxable year intends to submit in a subsequent taxable year, an application for covered loan forgiveness to the lender; and
• In a subsequent taxable year, the lender notifies the taxpayer that forgiveness of all or part of the covered loan is denied, or the taxpayer irrevocably decides not to seek forgiveness for some or all of the PPP loan (e.g., a taxpayer determines that it will not qualify for loan forgiveness and withdraws the loan forgiveness application).

Under the safe harbor, a taxpayer may be able to deduct non-deducted eligible expenses on (1) the taxpayer’s timely filed, including extensions, original tax return or information return, as applicable, for the 2020 taxable year; (2) amended return or administrative adjustment request under BBA partnership rules  for the 2020 taxable year, as applicable; or (3) the taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for the subsequent taxable year. 

A taxpayer applying the safe harbor must provide a statement with specified required information to the tax return on which the taxpayer deducts the non-deducted eligible expenses.

Observation

The underlying question remains whether expenses paid with forgiven loans are appropriately non-deductible or deductible.  Clearly, the IRS has spoken, but there remains a political issue – if another COVID-19 stimulus package is enacted, be it in 2020 or in 2021, it is certainly possible that the deductibility issue could be addressed and the IRS position reversed as part of the legislation.  But, until such time, we now have an IRS revenue ruling affirming such forgiven loan expenses as non-deductible and a procedure for dealing with PPP loan forgiveness where it is neither approved nor denied until 2021.