On November 18th, the Treasury released new guidance concerning the tax treatment of expenses paid with Paycheck Protection Program (PPP) loan funds. Newly issued Revenue Ruling 2020-27 provides that recipients of PPP loans may not deduct expenses paid with PPP funds in the year in which such expenses were paid or incurred. The Ruling further states that non-deductibility applies even if the taxpayer has not submitted an Application for Forgiveness by the end of the year.
The Treasury also released Revenue Procedure 2020-51 which provides a safe harbor and procedures for taxpayers to later deduct expenses paid with PPP loan funds if forgiveness is subsequently denied or the taxpayer decides to not apply for forgiveness.
These pronouncements give no guidance as to whether a “Schedule C” independent contractor or sole proprietor will have loss of a deduction for the “income replacement” portion of their PPP loans not related to any payments for deductible items on those taxpayers’ Form 1040, Schedule C.
Revenue Ruling 2020-27 provides that expenses cannot be deducted by a calendar year taxpayer in 2020, if the taxpayer reasonably expects to receive forgiveness. The Ruling indicates that forgiveness can be reasonably expected as the CARES Act, and guidance published by the SBA, provide taxpayers with “clear and readily accessible guidance” to know by year end the amount of eligible expenses that have been spent to qualify for loan forgiveness. For those of us who have been following the SBA PPP pronouncements, SBA guidance has been far from “clear and readily accessible”! However, at this point, it seems clear that a great many borrowers will receive full forgiveness..
Revenue Procedure 2020-51 provides a safe harbor and procedures for taxpayers who either (1) do not apply for full forgiveness in 2020, or (2) as to which forgiveness that was expected in 2020 is denied.
In order to be eligible for the safe harbor, the taxpayer must meet all three of the following requirements:
- The taxpayer paid or incurred eligible expenses with PPP loan funds in the 2020 taxable year and took no deduction whatsoever for the payment of such expenses because at the end of the 2020 taxable year the taxpayer reasonably expected to receive loan forgiveness.
- The taxpayer submitted the Loan Forgiveness Application in 2020, or intends to submit the Loan Forgiveness Application after 2020.
- During 2021 or thereafter, either (a) the lender notifies the taxpayer that forgiveness of all or part of the covered loan is denied, or (b) the taxpayer irrevocably commits not to seek forgiveness for some or all of the covered loan.
Taxpayers meeting the above criteria can either deduct the expenses on its 2020 tax return or in the year in which the loan forgiveness is denied. Taxpayers will likely be better off deducting expenses in the year in which forgiveness is denied if the 2021 economy is better than it has been in 2020 and/or if Congress, under the Biden administration, raises the income tax rates.
The taxpayer must also include a statement with the return on which the expenses are deducted entitled “Revenue Procedure 2020-51 Statement,” and must include the following:
- The taxpayer’s name, address, and social security number or employer identification number;
- A statement specifying whether the taxpayer is an eligible taxpayer under either section 3.01 or section 3.02 of Revenue Procedure 2020-51;
- A statement that the taxpayer is applying section 4.01 or section 4.02 of Revenue Procedure 2020-51;
- The amount and date of disbursement of the taxpayer’s covered loan;
- The total amount of covered loan forgiveness that the taxpayer was denied or decide to no longer seek;
- The date the taxpayer was denied or decided to no longer seek covered loan forgiveness; and
- The total amount of eligible expenses and non-deducted eligible expenses that are reported on the return.
There has been bi-partisan support on Capitol Hill for relief from the IRS position of non-deductibility of expenses paid from PPP-loan proceeds, but relief has not been, to date, been passed. Congress has indicated that any relief would be included with other legislation such as a possible PPP 2 program or a forthcoming additional stimulus bill.
At this point, if forgiveness is reasonably expected, then expenses that are counted towards forgiveness cannot be deducted in 2020. If the taxpayer does not reasonably expect full forgiveness, or plans to return the loan, then the applicable expenses may be deducted in 2020.