PPP Expense Deductibility
With recent guidance, IRS has reinforced its position of disallowing expense deductions related to Paycheck Protection Program (PPP) loans. The guidance could have a considerable impact on year-end tax planning.
Before we jump into the recent IRS guidance, it’s helpful to understand how we got to this point. The CARES Act, signed into law in late March, created the PPP. This unprecedented program incentivized businesses and nonprofits to maintain payroll spending, funded by government backed forgivable loans. As long as borrowers used loan proceeds to pay eligible expenses (payroll, rent, utilities etc.) during a covered period, the loan would be forgiven. Under Section 1106(i) of the CARES Act, PPP loan forgiveness would not result in taxable income.
Despite the clear intent of Congress to exempt PPP loan forgiveness from being taxed, IRS issued Notice 2020-32 in late April which held that expenses claimed for purposes of receiving PPP loan forgiveness would not be deductible. This position effectively made PPP loan forgiveness a taxable event via the disallowance of tax deductions. IRS claimed loan forgiveness was akin to tax-exempt income, thus the associated expenses were not deductible.
In June, Congress passed the PPP Flexibility Act which among other things, extended the loan covered period to 24 weeks and lengthened the deferred payment window. These changes increased the likelihood that many borrowers would have outstanding PPP loans at year end.
Rev. Rul. 2020-27 / Rev. Proc. 2020-51
Based on IRS arguments emphasized in Notice 2020-32, many taxpayers planned to push loan forgiveness into 2021 which would effectively defer the tax hit. However, IRS has attempted to quell this strategy with its recent guidance.
Revenue Ruling 2020-27 essentially prohibits taxpayers from deducting PPP related expenses if loan forgiveness is “reasonably expected.” The ruling aims to shut down the strategy of delaying PPP loan forgiveness in order to deduct the expenses in a prior tax year.
Revenue Procedure 2020-51 was issued in conjunction with the Revenue Ruling and provides a safe harbor for deducting PPP expenses if any portion of the PPP loan is ultimately not forgiven.
Many in the tax community disagree with arguments IRS has put forth in their recent guidance. Legislators on both sides of the aisle have publicly voiced disagreement with IRS and their position to effectively tax PPP loan forgiveness. IRS has stated that legislative action is required to change their position. Several bi-partisan bills have been introduced to remedy the issue, but nothing has passed to date. Many experts believe Congress will ultimately act, but timing is still a big question.
This puts taxpayers in a tough spot. Fourth quarter estimated tax payments for the 2020 tax year are due 1/15/21. Many have not considered the potential tax impact of PPP on their 2020 returns. Consideration should be given to recalculating Q4 estimated tax payment amounts to avoid possible underpayment penalties. Fiscal year taxpayers should also consider whether protective tax payments are needed.
With regards to submitting PPP forgiveness applications, we continue to believe a “wait and see” approach is most prudent. For most, delaying submission of the forgiveness application until 2021 still allows the greatest amount of planning flexibility. As always, your unique set of facts and circumstances should be evaluated before a decision is made. Contact us today to discuss the best strategy for you.