Richard J. Wright, Jr. CPA
Director | Tax Practice
On November 18th the IRS issued Revenue Ruling 2020-27 and Revenue Procedure 2020-51, clarifying their position regarding the deductibility of expenses paid with Paycheck Protection Program (PPP) funds.
Back in May of this year, the IRS issued Notice 2020-32 stating that “no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of the covered (PPP) loan.” In simpler terms, this meant that although the receipt of the PPP funds were not considered taxable income, if you used the funds for eligible expenses (payroll, rent, mortgage interest and utilities), and the funds were later forgiven, then the expenses associated with those funds would not be deductible for income tax purposes.
This created angst within Congress and bi-partisan efforts in both the Senate and House of Representatives. Legislators cried “foul” by asserting that the congressional intent within the spirit of The CARES Act was for taxpayers to also be able to deduct the eligible expenses, thereby not inflating their taxable income (more on this in a minute).
It is important to remember that Revenue Rulings are not codified law. They are the IRS interpretation of a law, regulation, or specific Act. A Revenue Procedure provides instructions on how to comply and implement a Revenue Ruling.
This recent Revenue Ruling provides the IRS interpretation on whether a PPP loan participant that has paid or incurred eligible expenses can 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. The revenue ruling also includes guidance if, as of the end of the 2020 tax year, the PPP loan participant has not applied for forgiveness, but intends to apply in the next taxable year. It also states that even if the borrower has not received or applied for forgiveness by year end but has a “reasonable expectation” that the PPP will be forgiven, then the taxpayer should not deduct the expenses in 2020.
Many practitioners believed a more than reasonable interpretation of the CARES Act and IRS Notice 2020-32, stating “no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of the covered loan,” instead of the current interpretation. The CARES Act or IRS Notice do not state the concept of “reasonable expectation.”
Revenue Procedure 2020-51 provides a safe harbor which does permit taxpayers to deduct eligible expenses in 2020 if:
- The eligible expenses are paid or incurred during the taxpayer’s 2020 taxable year
- The taxpayer received a PPP loan and at the end of the year the taxpayer expects the loan forgiven in a taxable year after 2020, and
- In that subsequent taxable year, the taxpayer’s request for forgiveness is denied or the taxpayer never requests forgiveness.
Back to what I mentioned with respect to Congress and their original intent, here is an excerpt of a joint bi-partisan statement released a few hours after the new IRS guidance was delivered, from Senators Chuck Grassley (R – Iowa) and Ron Wyden (D-Oregon) to the US Treasury:
“Since the CARES Act, we’ve stressed that our intent was for small businesses receiving Paycheck Protection Program loans to receive the benefit of their deductions for ordinary and necessary business expenses. We explicitly included language in the CARES Act to ensure that PPP loan recipients whose loans are forgiven are not required to treat the loan proceeds as taxable income. As we’ve stated previously, Treasury’s approach in Notice 2020-32 effectively renders that provision meaningless. Regrettably, Treasury has now doubled down on its position in new guidance that increases the tax burden on small businesses by accelerating their tax liability, all at a time when many businesses continue to struggle and some are again beginning to close. Small businesses need help maintaining their cash flow, not more strains on it.”
“We encourage Treasury to reconsider its position on the deductibility of these expenses, and the timing of those deductions, to provide relief to the small businesses that need it most.”
What does all this mean? Either the IRS is trying to assist taxpayers with year-end tax planning (ok, stop laughing) or perhaps they are trying to pressure Congress to pass the required amendment to the CARES Act that would clean up not only this issue, but a variety of others.
It further reinforces as with most of 2020, situations continue to evolve, sometimes rapidly. Currently, there are many new issues that are unanswered which continue to surface by these recent IRS pronouncements (ordering rules, allocations, etc). Thus, we still believe for most taxpayers that a wait and see approach is prudent vs. rushing to file for forgiveness.