Timing and Deductibility of PPP-Funded Expenses (New Guidance in Revenue Ruling 2020-27 and Revenue Procedure 2020-51)
Coauthored by Stanley Rose
On November 18th, 2020 the IRS issued Revenue Ruling 2020-27 and Revenue Procedure 2020-51. This guidance provides some answers long awaited by taxpayers and their advisors addressing (1) whether expenditures made with PPP loan funds are tax-deductible and (2) the year in which the deductions are allowed.
This article assumes readers are familiar generally with the Paycheck Protection Program created by the CARES Act. For more information regarding the program, please review our June 5 article or the various links within it.
It also assumes (and getting to the purpose of this article’s update) that readers are familiar specifically with a disagreement between some members of Congress and Treasury, leading to confusion over how to treat expenditures made with PPP loan funds – mainly, are those outlays deductible, and if so, when? Colleague Matt Landon explained this in more detail in a May 21 article, but the following paragraph will bring you up to speed with where things stood right before Revenue Ruling 2020-27 and Revenue Procedure 2020-51 were issued:
From a taxpayer’s perspective, PPP funds involve two primary movements: The influx of cash received from the SBA via a lender and the expenditures paid with those funds by the taxpayer. We know that the influx is not taxable. If forgiven, Sec. 1106(i) of the CARES Act specifically excludes it from taxable income. If not forgiven, it per se is not taxable, because it merely represents the front end of a loan that will be repaid. On the expenditure side, outlays related to non-forgiven loans are deductible (or not deductible) under normal rules of expense deductibility, completely unaffected by the fact that their roots are in PPP loans. It is the treatment of expenditures made from forgiven (or expected to be forgiven) loans that have created confusion. In May, the Treasury Department issued Notice 2020-32 stating that otherwise deductible expenses made from forgiven PPP loans were nondeductible, the theory apparently being that it would create double-dipping. However, several members of Congress (Democrats and Republicans) quickly told Treasury Secretary Mnuchin that Congress fully intended for those outlays to be deductible, as a way to make the benefit more potent for taxpayers. They explicitly asked him to reverse his position, but Treasury has been silent (and leaving taxpayers and practitioners stewing for half a year) until now, when with the issuance of Revenue Ruling 2020-27 and Revenue Procedure 2020-51 it doubled down on its stance, and provided some clarity on how to implement it.
With that background, we now turn to the new guidance. The article will first tackle Revenue Ruling 2020-27 and then Revenue Procedure 2020-51.
Revenue Ruling 2020-27
One of the many lingering questions (especially after the covered period was extended to 24 weeks) was the timing of the expense deduction disallowance. As noted above, Treasury issued Notice 2020-32 earlier this year that told us that expenses funded with forgiven loan proceeds are not deductible. While many held out hope this would be reversed, we also pondered another question that could present itself if Notice 2020-32 survived: What happens if the loan proceeds and forgiveness straddle two tax periods? Let’s say an entity with a calendar year end received a PPP loan and used all the proceeds on expenses during 2020 but did not receive forgiveness of the loan until May 2021 (after the 2020 tax return filing due date). Does the expense disallowance occur on the 2020 return that was originally due before you received forgiveness or is the impact of the deduction disallowance felt on the 2021 return (the year the loan is forgiven)?
According to Revenue Ruling 2020-27, the year in which the disallowance occurs depends on whether or not the loan was “reasonably expected” to be forgiven at year-end. This reasonably expected guidance applies whether forgiveness was applied before 12/31/2020 or not. As long as the taxpayer reasonably expected forgiveness of the loan at year-end, then the IRS would deem deduction of the expenses as inappropriate on the 2020 tax return. Of course, “reasonably expected” is a vague term that leaves plenty of room for argument. Will the IRS use hindsight in an audit of the issue to actually look at whether the loan was forgiven after the fact? That remains to be seen. The most prudent action would be to maintain contemporaneous documents and explanations of your decision regarding “reasonably expected.”
Revenue Procedure 2020-51
While related to Revenue Ruling 2020-27, Revenue Procedure 2020-51 differs in that it primarily addresses mechanics. It provides a safe harbor for deducting expenses in a particular year when the PPP loan is fully or partially denied subsequent to year-end, or for those who decide to forego forgiveness. This safe harbor applies when the taxpayer (1) reasonably expected to receive forgiveness (per Revenue Ruling 2020-27) and (2) in the year subsequent to the loan, is notified that forgiveness is denied (in part or full) or decides to forego forgiveness.
In this scenario, the taxpayer has a number of options. Any qualifying expenses made from non-forgiven loans may be deducted on:
- An originally filed (including extensions) 2020 return;
- An amended 2020 return (if the return has already been filed); or
- A timely filed original tax return for the subsequent year (2021).
To utilize this safe harbor, a statement must be attached to the applicable return containing specific information outlined in the Revenue Procedure.
Observation: The detailed statement makes sense for use accompanying deductions elected to be taken in the subsequent year, but it seems like regular rules of deductibility would suggest full deduction is allowed in the year the outlays are incurred without the need for the safe harbor. However, it remains to be seen what type of hindsight the IRS might use in terms of how one would argue whether at year-end the taxpayer reasonably expected loan forgiveness. For that reason, we may want to consider attaching the safe harbor statement to the applicable return as a protective measure regardless of which year’s return reports the deduction. Perhaps more guidance will follow.
This guidance was long awaited for planning purposes, and while a six-month delay was not helpful, at least this materialized before year-end. However, some questions still remain: If disallowance occurs, in what order do you place payroll, utility, and rent expense disallowance? How does the disallowance affect things such as the Section 199A deduction or the Section 163(j) limitation? Will the IRS abide by taxpayers’ interpretations of “reasonably expected?”
Lastly, there does still appear to be some bi-partisan support for making these expenses fully deductible, which many argue was the intent. If that occurs, a law created by the legislative branch of government will overcome rulings like these issued by the executive branch. However, that bi-partisan support has existed for six months without anything coming to fruition. Whether or not anything develops before taxpayers begin filing 2020 returns or making extension payments is anyone’s guess, and in the meantime, we now have formal guidance that must be followed.
For more information or a discussion on how this may impact you, please contact Adam Aucoin or your BNN tax advisor at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.