The IRS just released Revenue Ruling 2020-27 and Revenue Procedure 2020-51 to clarify the rules for deducting expenses paid with PPP funds.
But here we are at the end of the year, and most borrowers have not even applied for forgiveness.
A change in government administrations is weeks away, and many small businesses desperately want to get these loans off their balance sheets.
Here is what you need to know.
IRS Denies PPP Tax Deductions Even If Loan Might Be Forgiven In Future
Expenses paid with PPP loan funds are not deductible provided the payment of the related expenses results in loan forgiveness. The phrasing “results in forgiveness” implies that the forgiveness needed to happen before this rule would kick in. That created a lot of angst because most borrowers would not have applied for forgiveness before the end of the year and thus weren’t sure whether to deduct the expense paid with the loan on their 2020 tax return.
However, IRS states that even if a borrower has “a reasonable expectation of reimbursement” the deduction is inappropriate. In short, even if forgiveness has not happened, borrowers can’t deduct expenses paid for with PPP funds if they reasonably believe the loan will be forgiven.
For example, if the taxpayer hasn’t applied for forgiveness by the end of 2020 (which will be the case for many of you out there) but has satisfied all of the requirements under the Coronavirus Aid, Relief and Economic Security Act (CARES Act) and expects to apply for forgiveness in 2021. The rule states “at the end of 2020 the taxpayer knew the amount of eligible expenses that qualified for reimbursement in the form of covered loan forgiveness and has a reasonable expectation of reimbursement.” Because that reimbursement of the loan was “foreseeable,” the taxpayer may not deduct the eligible expenses.
The IRS provides safe harbor which allows taxpayers to claim a deduction 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 to be forgiven in a taxable year after 2020, and
In that subsequent taxable year, the taxpayer’s request for forgiveness is denied or the taxpayer decided not to requests forgiveness.
Under the above scenario, the taxpayer can deduct expenses originally thought to be non-deductible on a timely filed return or can amend the return in the taxable year.
Conclusion
The new Rev. Rul. and Rev. Proc. reduce the incentive for taxpayers to apply for forgiveness before the new Biden administration and the new Congress take power in January. This has become frustrating for almost everyone involved (borrowers, lenders, tax professionals, etc.). The good news is we are all in this together, and we will figure it out. It just may take some patience and time before that happens.