When the Paycheck Protection Program (PPP) was introduced as part of the CARES Act in March, the law provided that any loan forgiveness would not be included in taxable income. The IRS released guidance in April that indicated that expenditures funded by PPP loan proceeds would not be deductible for federal income tax purposes to the extent of any loan forgiveness, essentially offsetting the tax-exempt loan proceeds. Legislation was introduced in Congress in May to explicitly provide that expenditures funded by loan proceeds would be deductible, regardless of loan forgiveness. Unfortunately, that legislation has never been enacted. The failure to provide a legislative solution means the IRS will stand by its position above.

Despite the earlier IRS guidance, uncertainty remained as to the timing of the disallowance of a deduction for expenditures funded by loans forgiven in whole or in part. This uncertainty is more pronounced when a loan is forgiven in a different tax year (for example 2021) than when the expenditures were incurred and normally deducted (for example 2020). Late Wednesday, the IRS released long-awaited guidance on this timing issue.

Revenue Ruling 2020-27 holds that a taxpayer computing taxable income on the basis of a calendar taxable year may not deduct PPP funded expenditures in its 2020 taxable year if, at the end of the 2020 taxable year, the taxpayer has a reasonable expectation of PPP loan forgiveness on the basis of the eligible expenses it paid or accrued during the covered period. This holding applies even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.

Revenue Procedure 2020-51, provides a safe harbor which 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 the taxpayer expects the loan 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.

Under the above scenario, the taxpayer is allowed to deduct expenses originally thought to be non-deductible on a timely filed return or can amend the return in the taxable year. Extending 2020 calendar year returns might be advisable for some taxpayers who will be applying for loan forgiveness in 2021.

This email is a brief summary of the guidance released on Wednesday, November 18. For additional questions regarding deductibility of PPP loan-related expenses, please contact your Smith Leonard professional or email us.