The Paycheck Protection Program was the centerpiece of the CARES Act, providing loans to businesses of up to $10M. Compliance with this meant that loads did not have to be paid back. Also, there is no forgiveness of debt income when a loan is forgiven, something that normally is a standard tax result from a forgiven loan.
Now businesses are asking if they can claim tax deductions for business expenses. When it comes to the Paycheck Protection Program (PPP), it has been a question with no clear answer from the start.
On Wednesday, November 18th, 2020 the IRS issued guidance on the disallowance of otherwise deductible expenses that are paid with forgiven PPP funds.
Notice 2020-32 stated that loan proceeds received under PPP which was forgiven were similar to tax-exempt income. The Internal Revenue Code states that expenses related to tax-exempt income are not deductible. The IRS denied tax deductions even for expenses that are normally fully deductible. The IRS says allowing a deduction would be a double dip.
Congress quickly moved to reverse the IRS in the Small Business Expense Protection Act, S.3612 – 116th Congress (2019-2020). That bill languished and has still not passed, although Congress could still reverse IRS denial of tax deductions.
Revenue Ruling 2020-27
Revenue Ruling 2020-27 gives two examples of taxpayers that received PPP funds in 2020. Both taxpayers used the PPP funds for their intended purpose (payroll, rent, utilities and mortgage interest). The first taxpayer applied for forgiveness of their PPP loan in 2020 but did not have an answer by December 31, 2020 as to whether the loan was forgiven. The second taxpayer did not apply for forgiveness until 2021 but just as the first taxpayer had done, used the proceeds to pay only eligible expenses within the covered period.
Ruling 2020-27 states that since both taxpayers reasonably expected forgiveness then expenses paid with the forgiven PPP funds were not deductible. Keep in mind, even though neither taxpayer had received an answer on forgiveness just the reasonable expectation of forgiveness is enough to disallow the deductions.
You could file for an extension of the return in question, either by March 15th for S corporations or by April 15th for sole proprietorships, partnerships, or C corporations. An extension of time allows taxpayers an additional 6 months to file a return and taxpayers should have answers by the extended due date.
Rev Proc 2020-51
The IRS also released Rev. Proc. 2020-51, which provides a safe harbor for PPP borrowers whose loan forgiveness has been partially or fully denied and who wish to claim deductions for otherwise eligible payments on a return, amended return, or administrative adjustment request.
Revenue Procedure 2020-51 explains that a taxpayer that has part of their forgiveness denied may deduct expenses paid with PPP proceeds that are not forgiven. This may be done on either a timely filed 2020 tax return, an amended 2020 return if the original return was filed and did not include such expenses, or on the taxpayer’s 2021 tax return.
For guidance on CARES Act tax matters, please contact Lee Schmidt or other members of the A. L. Schmidt CPA Tax Practice.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.