Timing of Non-Deductibility of Forgiven PPP Loan-Funded Expenditures

In guidance issued on 11/18/2020, the IRS has made it clear that taxpayers with a “reasonable expectation” that their Paycheck Protection Program (PPP) loan will be forgiven may not deduct expenditures that were paid with the proceeds of those loans, even if the actual forgiveness has not yet been granted prior to the end of the taxable year (Revenue Ruling 2020-27). In this Revenue Ruling, the IRS states that, because the calculation of forgiveness is based on eligible expenses that were paid with PPP funds, the forgiveness of the loan amounts used for these eligible expenses is “reasonably expected to occur”, and therefore, under §265, claiming tax deductions for such eligible expenses would be not be appropriate.

In a statement which accompanied the guidance, the IRS stated “Since businesses are not taxed on the proceeds of a forgiven PPP loan, the expenses are not deductible. This results in neither a tax benefit nor tax harm since the taxpayer has not paid anything out of pocket.”

In making this statement, the IRS cites §265(a)(1), which disallows a deduction for otherwise eligible expenses to the extent the payment of those eligible expenses is allocable to tax-exempt income in the form of reasonably expected covered loan forgiveness. The IRS states that “the fact that the tax-exempt income may not have been accrued or received by the end of the taxable year does not change this 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.”

Examples of Timing of Non-Deductibility of Forgiven PPP Loan-Funded Expenditures

Rev Rul 2020-27 analyzes two fact patterns and determines that in either case, the deductions may not be taken on the current year return.

Situation 1

The taxpayer used PPP funds to pay payroll, mortgage interest, utility bills, and rent during the 2020 taxable year. 100% of the expenditures are expenses that qualify for forgiveness under the CARES Act. Although the taxpayer applies for loan forgiveness in November 2020, taxpayer is not advised as to whether the debt is forgiven prior to year-end.

The position of the Revenue Ruling is that, when the taxpayer completed the application for a covered loan forgiveness, they knew the amount of their eligible expenses that qualified for reimbursement, and therefore had a reasonable expectation of reimbursement of said expenses.

As such, the taxpayer may not deduct the eligible expenses for tax purposes in 2020.

Situation 2

The taxpayer paid the same type of qualified expenses as in Situation 1. In this situation, however, the borrower did not submit an application for forgiveness until the subsequent year, 2021. While the taxpayer in this Situation did not complete an application for covered loan forgiveness in 2020, at 12/31/20, taxpayer had satisfied all other requirements under CARES Act §1106 for forgiveness of the debt. Because the taxpayer expected to apply for forgiveness in 2021,

• they knew the amount of its eligible expenses that qualified for reimbursement, and
• they had a reasonable expectation of reimbursement.

As such, this taxpayer may also not deduct the eligible expenses for tax purposes in 2020.

Deductibility of Eligible Expenses When Forgiveness Not Sought, Nor Received

In a piece of companion legislation, Rev Proc 2020-51 states that taxpayers:

• who do not apply for forgiveness, or
• who did apply for forgiveness, but whose requests are reduced or otherwise denied,

may take tax deductions for expenditures that were paid with the loan proceeds that are not forgiven. The Revenue Procedure provides a “safe-harbor” for the taxpayers to claim deductions for otherwise eligible payments on:

• an original return,
• amended return, or
• administrative adjustment request.

Taxpayers Eligible to Take Tax Deductions

Rev Proc 2020-51 specifically states that taxpayers are eligible to take tax deductions if:

• Eligible expenses were paid or incurred in a taxable year beginning or ending in 2020, for which no deduction is permitted because at the end of the taxable year the taxpayer reasonably expects to receive forgiveness of the loan based on those eligible expenses (non-deducted eligible expenses); and

• An application for loan forgiveness was submitted before the end of the taxable year, or it is the intention that an application be submitted in a subsequent taxable year; and

• • The taxpayer’s lender notifies them that all or a part of the loan forgiveness is denied; or
• • The taxpayer withdraws the loan forgiveness application, or decides not to submit the application, because they determine they will not qualify for forgiveness.

Safe-Harbor Where Loan is Not Forgiven

Rev Proc 2020-51 states that “taxpayers may deduct the non-deducted eligible expenses in the year that the loan forgiveness is denied under general tax principles.” What this means is that, under general tax principles, taxpayers will deduct those expenses in 2021. Alternatively, if a taxpayer elects the safe-harbor, they may elect to deduct the expenses in 2020.

Taxpayers using the Revenue Procedure must make an affirmative election and must attach a required statement to the return.

Safe-Harbor Election Required Statement

To qualify for the safe-harbor, taxpayers must attach a statement to their return titled “Revenue Procedure 2020-51 Statement” that contains the following information:

• The taxpayer’s name, address, and Social Security number or employer identification number;

• A statement specifying whether the taxpayer is an eligible taxpayer under either §3.01 of the Revenue Procedure, for a taxpayer who applied for loan forgiveness in 2020 (or as of the end of the 2020 tax year intended to apply for loan forgiveness in a subsequent tax year) and the application was denied in whole or part, or under §3.02, for a taxpayer who applied for loan forgiveness in 2020 (or as of the end of the 2020 tax year intended to apply for loan forgiveness in a subsequent tax year) but in a later tax year decides to irrevocably withdraw its request for forgiveness;

• A statement that the taxpayer is applying the safe-harbor in §4.01 of the Revenue Procedure for expenses claimed in 2020 or §4.02 for expenses claimed in a later year;

• The amount and date of disbursement of the taxpayer’s loan;

• The total amount of covered loan forgiveness that the taxpayer was denied or decided to no longer seek;

• The date the taxpayer was denied or decided to no longer seek covered loan forgiveness; and

• The total amount of eligible expenses and nondeducted eligible expenses that are reported on the return.

Nothing in the Revenue Procedure prevents the IRS from examining tax returns to determine whether the taxpayers qualify to deduct the expenses in question.

(This is Blog Post #926)