New Guidance Issued by Internal Revenue Service (“IRS”) Clarifying the Deductibility of Expenses for Businesses Who Have Received a Paycheck Protection Program (“PPP”) Loan
The PPP was created as part of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act to provide loans to small businesses negatively impacted by COVID-19. As long as the PPP borrower used its PPP loan proceeds on qualified business expenses, as outlined under the CARES Act, the entire amount of the PPP loan was eligible for forgiveness. As part of the terms of the CARES Act, the forgiveness of any PPP loan was excluded from the PPP borrower’s gross income for federal tax purposes. However, the CARES Act did not specifically address whether the expenses that were paid using the PPP proceeds would continue to be deductible.
On November 18, 2020, the IRS issued Revenue Ruling 2020-27, stating that a “taxpayer that received a loan guaranteed under the [PPP], and paid or incurred certain otherwise deductible 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 [PPP] 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.”
Additionally, the IRS issued Revenue Procedure 2020-51, which provides a safe harbor for PPP borrowers to claim a tax deduction for expenses paid using PPP funds if the PPP borrower is later denied PPP loan forgiveness or forgoes PPP loan forgiveness. The safe harbor allows eligible PPP borrowers to deduct some or all of the eligible expenses on its original 2020 tax return, an amended 2020 tax return, or 2021 tax return.
This means that a PPP borrower who expects to receive PPP loan forgiveness will not be allowed an income tax deduction for expenses paid in 2020 with PPP loan proceeds, even if the PPP loan is not forgiven until 2021. To the extent that these expenses are not deductible, the PPP borrower’s taxable income increases as a result of the loan forgiveness and the result is the same as if the discharge of the PPP loan was taxable. This outcome could negatively affect a PPP borrower by increasing its taxable income and reducing its potential net operating losses.
Due to the negative tax consequences associated with the IRS guidance, the American Institute of CPAs (AICPA), along with hundreds of business and trade organizations, have called on Congress to pass legislation before the end of 2020 to make it clear that expenses related to a forgiven PPP loan are tax deductible. Without such legislation, the group warned there could be a surprise tax increase of up to 37% on small businesses when they file their taxes for 2020.
Information contained in this alert is for general information purposes only. It should not be considered as legal advice or the sole source of information when analyzing and resolving a legal issue. If you have specific questions regarding your particular circumstances, please do not hesitate to contact your CH& counsel.