As many practitioners and taxpayers know, the Paycheck Protection Program was created by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which Congress enacted in March. The PPP program provides loans that can be forgiven tax free if portions of the proceeds are spent on items such as payroll.
However, immediately after Congress passed the CARES Act, questions arose whether expenses funded with PPP loans would be deductible if the loans were forgiven. Soon after, the IRS issued Notice 2020-32, 2020-21 IRB 837, which stated that expenses funded with the forgiven PPP loans would not be deductible—avoiding a double tax benefit to businesses. But that Notice still did not answer the question that many practitioners raised: would expenses funded with a PPP loan be deductible if the loan was not forgivable until a subsequent year?
That question was finally answered on November 18, 2020 with the issuance of Rev. Rul. 2020-27, 2020-50 IRB 1. The IRS answered in the negative—basing its analysis on a “reasonable expectation” of loan forgiveness. Specifically, in t Rev. Rul. 2020-27, the IRS presented two scenarios as examples. In the first scenario, a borrower pays expenses such as payroll and mortgage interest that qualify under the CARES Act as valid PPP expenditures. The borrower applies for forgiveness in November 2020 and satisfies all the requirements under the CARES Act for loan forgiveness. But the borrower does not yet have an answer as to whether it will be forgiven. In the second scenario, the borrower pays the same type of valid expenses with its PPP loan and satisfies the CARES Act requirements for the loan, but the borrower expects to apply for forgiveness in 2021.
The IRS notes that the expenses in both scenarios would not be deductible because both borrowers had a reasonable expectation of loan forgiveness. Specifically, the IRS provided as follows:
A taxpayer that received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act 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.
This may seem like a harsh outcome to many taxpayers given the unprecedent relief provided by Congress amidst one of the worst economic crises in the history of the United States. But the IRS did provide a safe-harbor to taxpayers in Rev. Proc. 2020-51, 2020-50 IRB 1. This provides relief to taxpayers who have been partially or fully denied loan forgiveness. Under this safe harbor, the taxpayer can otherwise deduct eligible payments on a return, amended return, or administrative adjustment request.
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