Another Chapter in the PPP Loan Forgiveness and the Deductibility of Expenses
On December 27th, the President signed the Consolidated Appropriations Act, 2021 (CAA 2021). In it, Congress made it very clear as to its intentions of deductibility of PPP loan funded expenses, and the non-taxability of forgiven PPP loans. As this legislation is a direct contradiction of the current Internal Revenue Service rulings, reconciliation or withdrawal of the current Rulings and Procedures will need to take place. Section 276 of CAA 2021 lists the following:
- No PPP Loan forgiven is included in gross income as debt forgiveness and;
- No deduction is disallowed, no tax attribute reduced and no basis increase denied for forgiven amounts.
Given this law change, the PPP money is not taxable income, and the remainder of this article is now outdated just as this newsletter went to press.
Congress specifically provided that forgiven PPP loan dollars are tax exempt income. And while that was clearly their intention, the legislators failed to observe a long-standing rule that expenses funded by tax-exempt income are not deductible. In other words, whatever your PPP forgiveness amount is – it will increase your net taxable income by the same amount. This blind-sided both Congress and taxpayers.
Revenue Ruling 2020-27, recently released, is in an attempt to clarify the timing of non- deductibility of expenses paid with monies from the Paycheck Protection Program (“PPP Loans”).
This ruling disallows 2020 deductions for these expenses which the taxpayer reasonably expects will be forgiven – even if the forgiveness isn’t applied for or confirmed until 2021.
For example, assume a taxpayer paid for otherwise deductible expenses: payroll costs, interest on a qualifying mortgage, utilities, and rents with money from a “PPP Loan” and before the end of 2020, the taxpayer applied for forgiveness. However, as of December 31, 2020, the taxpayer has not received confirmation of forgiveness.
In this instance, the IRS ruled the taxpayer is not permitted to claim deductions for the eligible expenses (payroll costs, interest on a qualifying mortgage, utilities, and rents) on its 2020 income tax return.
Treasury said in the November 18th press release of Rev. Rul. 2020-27 “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.” The IRS stands by the notion that taxpayers will be able to reasonably determine forgiveness and know what the tax adjustment should be for the 2020 tax year.
It had been speculated if a taxpayer waited until 2021 to apply for forgiveness, that the income could effectively be deferred until 2021. Revenue Ruling 2020-27 effectively voided this planning possibility.
Revenue Ruling 2020-27 is now part of the current income tax rules which require compliance. However, included in the currently unpassed PPP2 legislation now in Congress is language to allow deductibility of these same expenses. Unfortunately, until (and if) Congress passes the PPP2 legislation and reconciles this issue with the Service, the current Revenue Ruling is the law of the land.
Also released November 18, Revenue Procedure 2020-51 provides a safe harbor for certain Paycheck Protection Program loan taxpayers, whose loan forgiveness has been partially or fully denied, or for those who have decided to forgo loan forgiveness, to claim a deduction for certain otherwise deductible eligible payments. While I’m not sure why anyone would forgo forgiveness, but if they do, the safe harbor also allows these taxpayers to claim a deduction for the otherwise deductible eligible payments on an original income tax return.
To claim a deduction under this safe harbor for expenses paid or incurred in the taxpayer’s 2020 tax year:
- The taxpayer obtains a PPP loan and the taxpayer expects the loan to be forgiven in a tax year after the 2020 tax year and;
- In a subsequent tax year, the taxpayer’s request for forgiveness of the PPP loan is denied (either in whole or in part), or the taxpayer decided never to request forgiveness of the PPP loan.
A Taxpayer satisfying the safe harbor is permitted to deduct otherwise nondeductible expenses;
- On the taxpayer’s timely filed, including extension, original 2020 return or amended return; or
- On a tax return for a subsequent tax year.
In order to claim a deduction, the taxpayer is required to attach to the return a statement titled “Revenue Procedure 2020-51 Statement” that must include specific items, including a statement specifying the grounds for eligibility.
With the release of the both the Revenue Ruling 2020-27 and Revenue Procedure 2020-51, the landscape of how to deal with deductibility of expenses supported by PPP loans may not be clear based on your specific circumstances. Contact your Ketel Thorstenson tax advisor to discuss these issues for additional clarity.