By: Robert G. Tweel
The IRS has released guidance on the tax issues related to forgiveness of a PPP loan. In general, under the CARES Act, forgiveness of a PPP Loan is excluded from gross income for federal income tax purposes. The IRS has clarified that expenses covered by PPP Loan proceeds, namely payroll, are not deductible if the PPP Loan is forgiven. IRS Notice 2020-32.
Recent IRS guidance takes this issue a step further. “A taxpayer … may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.” Rev. Rul. 2020-27 (emphasis added).
Accordingly, if you received a PPP Loan in 2020, paid covered expenses, and reasonably expect forgiveness of all or a portion of the proceeds, you cannot deduct the expenses giving rise to forgiveness on your 2020 tax return. Note, this rule applies even if you have not submitted an application for forgiveness.
With this ruling, most taxpayers will likely not be able to deduct expenses paid with PPP Loan proceeds that gave rise to forgiveness in 2020 which will increase their taxable income by the amount of such expenses based upon IRS Notice 2020-32.
WHAT HAPPENS IF THE REASONABLE EXPECTATION IS INCORRECT
At the same time as it released Rev. Rul. 2020-27, the IRS also released guidance on what happens if forgiveness is ultimately denied or if the taxpayer abandons seeking forgiveness. See, Rev. Proc. 2020-51. Under this guidance, if in a subsequent year a taxpayer’s forgiveness is denied or the taxpayer decides never to seek forgiveness, the taxpayer may either deduct the expenses in 2020 or deduct the expenses in the year of the denial or abandonment. The Rev. Proc. sets forth detailed guidance on qualification for this deduction including the submission of a statement with the taxpayer’s return setting forth the basis for the taxpayer’s deduction of the expenses (i.e. denial or abandonment). This guidance reinforces the position set forth in Rev. Rul. 2020-27 for the denial of the deduction in 2020 based upon reasonable expectation of forgiveness. The main purposes of the guidance is to address how to treat deductions which were not allowable under Rev. Rul. 2020-27 when subsequent facts (denial or abandonment) make clear the taxpayer should have received the deduction.
This IRS guidance not only supports the position of non-deductibility set forth in Notice 2020-32 for PPP Loan expenses where the loan is ultimately forgiven, it goes even further to put the denial of these expenses into 2020 rather than the year of forgiveness.