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IRS Releases Paycheck Protection Program Guidance on Deductibility

by John Schweisberger, Matt Petroski

The Paycheck Protection Program (PPP) continues to cause challenges to borrowers almost eight months after the CARES Act passed. As many borrowers have recently completed their loan forgiveness applications or are nearing a point where they are ready to file, one large looming tax question has been how to handle the deduction of allowable expenses included in the loan forgiveness application.

The Internal Revenue Service (IRS) initially caused a stir with Notice 2020-32 (Notice), announcing the position that the expenses included in loan forgiveness are not deductible since they are related to the forgiven income that the CARES Act, specifically excluded from federal income. Many practitioners questioned the correctness of this interpretation but hoped that it would be legislatively fixed.

IRS Chief Counsel Michael Desmond recently mentioned at an American Bar Association tax meeting that the IRS has heard the criticism of its deductibility in the Notice, and he was asked whether the IRS would change its position. In response, he indicated that the IRS has received “a lot of questions on that, and we are certainly considering those questions.” He continued to note that the IRS was considering issuing guidance. If anyone thought this guidance would result in a favorable resolution for taxpayers, they will be disappointed with Revenue Ruling 2020-27 and Revenue Procedure 2020-51. These rulings offer clarity in how to treat non-deductibility from a tax return perspective, but they maintain the IRS’ previous position.

Revenue Ruling 2020-27

This Revenue Ruling amplifies the Notice and sets out two factual situations, one where the borrower applies for loan forgiveness in 2020 and another that files in 2021. The ruling sets out the legal framework of support for the IRS’ position. Ultimately, the Revenue Ruling indicates that it doesn’t matter if a taxpayer applied for forgiveness in 2020, or waits until 2021, since the amount is foreseeable in both situations. Therefore, taxpayers can’t deduct the expenses on their 2020 tax return.

Revenue Procedure 2020-51 (Safe Harbor)

This Revenue Procedure outlines the safe harbor situations where you can deduct these expenses in 2020. To do so, the taxpayer must meet the following:

  1. Expenses were paid or incurred in 2020,
  2. The taxpayer received PPP loan and expects to be forgiven after 2020, and
  3. In the subsequent tax year, loan forgiveness is denied in whole or in part, or the taxpayer decided never to request forgiveness.

If a taxpayer qualifies for the safe harbor, they can deduct on the following returns:

  1. 2020 original return,
  2. 2020 amended return, or
  3. 2021 return (subsequent tax year).

There is a specific statement that needs to be attached (details in the Revenue Procedure) to the tax return in order for a taxpayer to take the deduction, so taxpayers taking advantage of this safe harbor should be aware of this to ensure deductibility.

What you need to know

Members of Congress, practitioners and taxpayers have called on the IRS to change its position and allow the deductibility of expenses included in PPP loan forgiveness applications. However, these IRS determinations make it clear that it is up to Congress to pass legislation that allows for deductibility and allows for taxpayers who apply for forgiveness to deduct those expenses on their tax returns.

Here are a few things we suggest you review, as appropriate, going into year end:
  • Consider Q4 estimates due December 15, 2020. Make sure you have enough paid in to cover your tax liability without deducting expenses included, or to be included, in your loan forgiveness application.
  • Consider extending your tax return to allow for a possible legislative fix.
  • For some taxpayers, consider whether the after-tax benefits of applying for loan forgiveness make sense.
  • Revisit your certification of need considering recent SBA Forms 3509 and 3510 for borrowers of $2 million or more ( see our earlier article SBA Begins PPP Audits - What You Need to Know)

In the meantime, we will continue to monitor developments related to PPP loans. Reach out to your local Armanino advisor if you have additional question or concerns specific to your tax situation.

November 20, 2020

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