On November 18, 2020, the IRS provided additional clarity in the form of a revenue procedure and revenue ruling related to timing of Paycheck Protection Program (PPP) expenses and whether they are deductible on 2020 returns.
Revenue Ruling 2020-27
This ruling provides additional detail in the form of two examples of forgiveness situations:
Situation 1: Taxpayer obtains a PPP loan, uses the funds for eligible expenses, and applies for forgiveness before the end of 2020. The taxpayer reasonably expects the loan to be forgiven based on the funds being used for eligible expense, however the taxpayer has not heard back from the lender on whether the loan is forgiven by the end of 2020.
Situation 2: The same situation as in A applies; however, the taxpayer did not apply for forgiveness by the end of 2020 and expects to apply for forgiveness in 2021.
In both instances, the taxpayer reasonably expects their loan to be forgiven. As a result, the expenses related to this loan are not deductible. According to the revenue ruling, “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.” In other words, even if the forgiveness has not officially occurred, borrowers cannot deduct expenses paid with PPP funds if they reasonably believe the loan will be forgiven.
The IRS’ argument for this position is that the PPP program essentially provided tax-free income to many taxpayers with the understanding that these funds would be used for eligible expenses. As these funds are tax-exempt and not reported on 2020 taxable year returns for borrowers, disallowing the expense prevents taxpayers from “double dipping” and deducting expenses for which they have essentially been reimbursed (or are planning to be reimbursed).
Revenue Procedure 2020-51
This guidance provides a safe harbor allowing a taxpayer to claim a deduction in their 2020 taxable year (years beginning or ending in 2020), as long as the following criteria are met:
- The eligible expenses are paid or incurred during the taxpayer’s 2020 year
- The taxpayer received a PPP loan during the year and expects the loan to be forgiven in a subsequent tax year (2021 or after)
- The loan ultimately was not fully forgiven in the subsequent year (whether due to not applying or having the application denied)
Essentially, if the above three criteria are met and the taxpayer’s loan is not forgiven, they can deduct the eligible expenses. However, if the taxpayer has a reasonable expectation that the loan will be forgiven at the end of the tax year in which the expenses were incurred, then the taxpayer may not deduct the expenses on the 2020 return.
How to Deduct Expenses
For taxpayers who are looking to deduct eligible expenses and are not expecting their loan to be forgiven, the procedure states they must attach a statement to their return on which they are claiming the expenses. The statement must include the following:
- Name, address, social security number, or EIN
- A statement specifying whether the taxpayer is an eligible taxpayer under either section 3.01 or section 3.02 of RevenueProcedure 2020-51
- A statement that the taxpayer is applying section 4.01 or section 4.02 of Revenue Procedure 2020-51
- The amount and date of disbursement of the loan
- The total amount of loan forgiveness that was denied or the taxpayer has decided not to seek
- The date the loan was denied, or a statement showing the taxpayer decided not to seek forgiveness
- The total amount of eligible expenses and non-deducted eligible expenses
Additional guidance may be forthcoming as the SBA receives and reviews more forgiveness applications. Please note that there are several forgiveness applications and there is often not a “one size fits all” approach; therefore, consideration of all facts and circumstances is essential as we continue to navigate changes and new regulations. Please consult your tax advisor or feel free to reach out to any HHM professional for further guidance.