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On November 18, 2020, the IRS released guidance relating to the non-deductibility of expenses paid with Paycheck Protection Program (“PPP”) loan funds. The guidance builds on the IRS’s previously announced position, that recipients of PPP loans that used the proceeds to pay otherwise deductible expenses with PPP loan proceeds may not deduct those expenses, by clarifying that expenses paid with PPP loan proceeds may not be deducted in the year they were incurred if the taxpayer reasonably expects to receive forgiveness. This applies to situations where expenses are funded with PPP loan proceeds in 2020, but the loan is expected to be forgiven in 2021.

In Revenue Ruling 2020-27, the IRS laid out two scenarios. In scenario one, a borrower pays expenses such as payroll and mortgage interest that qualify under the CARES Act as valid PPP expenditures. In the first scenario, the borrower applies for forgiveness in November 2020 and satisfied all the requirements under the CARES Act to have the PPP loan forgiven, but doesn’t yet have an answer as to whether it will be forgiven at the end of 2020. In scenario two, the borrower paid the same type of valid expenses with its PPP loan proceeds and satisfied the CARES Act requirements for the loans, but expects to apply for forgiveness in 2021. According to the IRS, the borrowers in both scenarios can’t deduct the expenses funded with PPP proceeds because they have a reasonable expectation of forgiveness. The Ruling is available here.

The Ruling may impact PPP borrowers who were planning to wait until 2021 to apply for forgiveness. As the forgiveness application does not require the applicant to provide all expenses incurred during the covered period, but rather only those needed to get forgiveness, some PPP borrowers are planning to apply for forgiveness in 2021 to be able to determine the optimal amount and mix of expenses for forgiveness purposes. The increased time period and expense eligible for forgiveness is due to the Paycheck Protection Program Flexibility Act (the “Flex Act”).  See previous client alert. This is particularly true for PPP borrowers who are taxed as pass-through entities that qualify for the Qualified Business Income deduction (the 20% deduction) who may need deductible wages in order to utilize the deduction. 

The IRS also issued Revenue Procedure 2020-51 granting a safe harbor to allow certain taxpayers, who reasonably know that they will not get full forgiveness or will not apply for forgiveness, to claim a deduction on their 2020 tax return limited to those amounts.  The Procedure is available here. The Procedure allows taxpayers to claim a deduction in 2020 if:

• the eligible expenses are paid or incurred during the taxpayer’s 2020 taxable year;
• the taxpayer received a PPP loan and at the end of the year 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.

If a PPP recipient did not deduct expenses on its 2020 tax return and some or all of the loan it expected to be forgiven is not forgiven, it may either deduct the expenses on an amended return for 2020 or deduct the expenses on its 2021 tax return.

It is unclear whether taxpayers will challenge the IRS guidance, as well as the initial non-deductibility Notice issued in May. Further, lawmakers have continually expressed disapproval of the IRS’s position and may enact a legislative reversal.  Despite the possibility of a legislative fix, PPP recipients should be aware of the IRS’s position when deciding on what expenses should be included on the forgiveness application.

We are continuing to monitor changes and developments under federal and state tax law. If you have questions or concerns, please contact a member of the Koley Jessen Tax Practice Group.