On November 18, 2020, the IRS and Treasury Department released much-anticipated new guidance (Revenue Ruling 2020-27 and Revenue Procedure 2020-51), that indicates there will be no deduction for expenses paid with proceeds from a loan that is forgiven under the SBA’s Paycheck Protection Program (PPP).
The PPP loan program was passed as part of the CARES Act, providing small businesses a financial lifeline through the challenges caused by Covid-19. While PPP loans forgiven under the program are not considered taxable income, the question remained as to whether businesses would be allowed to claim deductions for costs covered by PPP funding (primarily payroll, utilities, rent and mortgage expenses).
The new guidance confirms the earlier position of the IRS: if a taxpayer received a PPP loan and paid otherwise-deductible expenses with PPP funds, those expenses are not deductible for federal tax purposes if the taxpayer reasonably expects to receive forgiveness of the loan. That is, businesses that “reasonably believe” their loan will be forgiven in the future may not deduct those costs, whether they have applied for forgiveness by the end of the 2020 tax year, or whether the actual forgiveness event has occurred. In either case, these expenses are not deductible in 2020.
The guidance also provides a safe harbor for taxpayers who do not deduct expenses in anticipation of their PPP loan being forgiven and whose forgiveness is later denied, in whole or in part, or for taxpayers who later decide not to request forgiveness. Therefore, if a borrower only has partial loan forgiveness, they may still have deductible expenditures attributable to the non-forgiven portion. Filers can take the write-offs on their 2020 or 2021 tax returns.
While the new guidance reaffirms the IRS position on the non-deductibility of expenses for PPP participants, it does not address other matters that could have significant tax implications, including:
- the qualified business income deduction,
- the research and development tax credit, and
- the business interest expense limitation.
Although we now understand there will be no deduction for expenses paid with proceeds of a forgiven PPP loan, additional clarification is still needed in these areas.
Possible Congressional Action
When the CARES Act was passed, the question of deductibility of expenses was not explicitly addressed, but several members of Congress have said it was their intention to allow the deductions. While it’s possible that Congress could pass legislation that makes the expenses deductible, it seems unlikely in a lame duck session. It seems more likely that new legislation would be passed in the end of January by the new Congress. Nevertheless, the recent IRS guidance may spur Congress to act sooner, as the deductibility of expenses seems to have bipartisan support.
What This Means for You
Congress seems eager to pass legislation allowing the deductibility of forgiven expenses, reversing the latest IRS guidance; however, there is no guarantee. If Congress hasn’t acted by the tax filing deadlines in March-April 2021, CSH will likely recommend that clients extend their 2020 tax filings in the hope that the proposed legislation will pass before the extended due date.
We will continue to closely monitor these issues and any future guidance or legislation related to the CARES Act. In the meantime, if you have any questions or would like to discuss your specific situation, please contact us or your Clark Schaefer Hackett representative.