By Demetrius Robinson & Jennifer Hart
The US Treasury Department and the Internal Revenue Service (IRS) released new guidance late Wednesday related to the tax treatment of expenses paid with Paycheck Protection Program (PPP) loans. Specifically, Revenue Ruling 2020-27 provides that regardless of whether the borrower has received forgiveness of their PPP loan, expenses paid with PPP funds are not deductible (the “Ruling”).
The Ruling supplements the IRS’s position on PPP loans that was initially announced in April’s Notice 2020-32 (the “Notice”). The Notice provided that companies that pay eligible, forgivable expenses with PPP funds may not also deduct such expenses as ordinary and necessary business expenses under Section 162 and Section 163(a) of the Internal Revenue Code. The result is that PPP loans are effectively being taxed as income, which, as discussed below, was not the intent of Congress when creating the PPP.
The IRS argues that allowing deductions for expenses paid with PPP funds would create a “double tax benefit.” However, this benefit was exactly what Congress intended. It is the Revenue Ruling that is directly counter to Congress’s intent. Congress specifically provided for favorable tax treatment of the forgiveness of PPP loans by including Section 1106(i) in the CARES Act. Section 1106(j) excluded the forgiven loan proceeds from income. This provision was critically important to the structure of the program: PPP loans were designed to effectively provide businesses that maintained their payrolls a tax-free grant. As an example, a business with $1,000,000 of income and a $150,000 PPP loan that was used in full on payroll could end up paying $30,000 more in taxes as a result of the Notice and Ruling.
Senators from both parties have contacted Treasury Secretary Mnuchin making this point, but the Ruling makes clear that the IRS will continue to ignore Congress’s clear intent to help small businesses survive the pandemic. KJK’s Managing Partner Jon Pinney and Chair of the Tax Practice Kevin O’Connor have been and continue advocating on behalf of Ohio’s small businesses on this issue.
Although the Small Business Administration (SBA) opened the forgiveness application portal in August, it appears that most companies have not rushed to obtain such forgiveness for a number of reasons, including the inability to deduct expenses. With companies not rushing to obtain forgiveness and the end of the year rapidly approaching, companies are concerned about how to classify expenses that have not yet been forgiven and/or an application for such forgiveness has not been made.
The Ruling appears to close a loophole from the Notice that PPP loans will not be forgiven in the same tax year that the expenses were incurred. The Ruling makes clear that taxpayers who have applied for PPP loan forgiveness and meet all the requirements for forgiveness but have not yet received notice of approval and reasonably expect that the application will be approved may not deduct any of the expenses covered by the PPP loan on their 2020 tax return. In addition, if a taxpayer has not applied for loan forgiveness, meets the requirements for forgiveness, and “reasonably anticipates” that they will apply for forgiveness in 2021, then they also may not deduct any of the eligible expenses covered by the PPP loan on their 2020 tax return.
The IRS did provide a safe-harbor for taxpayers who did not take a deduction in 2020 due to a reasonable belief that they would receive full forgiveness but then subsequently did not receive full forgiveness. Under Rev. Proc. 2020-51, if (1) a taxpayer paid or incurred eligible expenses during 2020, (2) received a PPP loan which was expected to be forgiven, and (3) in a subsequent tax year the loan forgiveness application was denied (entirely or partially) or never applied for PPP loan forgiveness then the taxpayer may take a deduction for the portion that was not forgiven by either taking such deduction on their 2020 tax return (if not already filed), filing an amended tax return or making an administrative adjustment request (AAR) under Section 6227 of the Internal Revenue Code.
Unfortunately, Congress has still failed to act in addressing IRS Notice 2020-32’s inability of PPP loan recipients to take a deduction for the expenses that they incurred under the PPP loan. With Congress headed out the door for the Thanksgiving holiday, there does not appear to be a likelihood of resolving this problem during the lame-duck session. Taxpayers who received PPP loans should carefully consult with their tax professionals to best understand what their options are and what strategies may be available. If you would like to contact your Senators or Congressperson about this issue, you can download a letter template here.
If you have questions about the tax consequences of the PPP or the CARES Act on your business, please contact Demetrius Robinson at djr@kjk.com or 614.427.5749 or Kevin T. O’Connor at kto@kjk.com or 216.310.4938, or reach out to any of our Tax professionals.