New Rules on PPP Forgiveness
The IRS released Revenue Ruling 2020-27 two weeks ago that addresses the timing of eligible expense deductions for businesses that have received a loan under the Paycheck Protection Program (PPP). Prior to the issuance of this Revenue Ruling, most businesses that received PPP loans were waiting to apply for PPP Loan forgiveness until 2021 in order to kick the deductibility issue down the road, which would have allowed them to go ahead and deduct the expenses in 2020 under the reasoning that the expenses hadn’t been forgiven yet and, therefore, were deductible. However, the recent revenue ruling provides that businesses that took out PPP loans cannot take a tax deduction for an eligible expense that is otherwise deductible if, at the end of this year, the business reasonably expects to receive forgiveness of the PPP loan even if the business has not submitted an application for forgiveness by the end of the year. In summary, if you received a PPP loan and you expect it to be forgiven because you’ve used the funds for covered eligible payroll, healthcare costs, rent and utilities, it doesn’t matter when you file for forgiveness (this year or next), you can’t deduct the expenses for 2020.
The PPP, one of the stimulus measures created by Section 1102 of the CARES Act, provides for the granting of loans to small businesses and nonprofit organizations in an effort to address the financial crisis and keep workers employed during the COVID-19 pandemic. A PPP loan recipient may use the funds to pay payroll costs, certain employee healthcare costs, interest on mortgage obligations, rent and utilities. Subject to specified limits, a borrower can apply to the lender for all or a portion of the PPP loan to be forgiven.
Section 1106(i) of the CARES Act provides that any amount of PPP loan forgiveness that would (but for that subsection) be includible in gross income instead will be excluded from gross income. However, the CARES Act is silent on whether eligible business expenses that result in PPP loan forgiveness are deductible for tax purposes. IRS Notice 2020-32 and newly released Revenue Ruling 2020-27 address this issue.
Based on the recent IRS notice and revenue ruling, a borrower will not be allowed to deduct expenses paid or incurred that result in the forgiveness of a covered PPP loan. Additionally, the income associated with the forgiveness is excluded from gross income. The IRS treats the forgiven amount as a class of “wholly” tax-exempt income as described in Section 265(a) or as expenses to be reimbursed and, therefore, expenses that are “allocable” to the tax-exempt income or subject to reimbursement are nondeductible. Similarly, in the case of expenditures that are required to be capitalized to the cost of inventory, such costs would not be capitalized and would not be taken into account in determining the taxpayer’s cost of goods sold.
PPP Loan Forgiveness Process
A PPP loan recipient can request forgiveness of the loan by submitting an application to the lender, together with required documentation. The lender will respond in one of four ways:
- Approve the application in the full amount requested by the borrower;
- Approve the application in part in an amount less than the amount requested by the borrower;
- Deny the application in full; or
- Deny the application without prejudice, a response that will be given when the SBA notifies the lender that a loan review is pending at the time the borrower submits the application.
If the borrower’s PPP Loan Forgiveness application is denied in whole or in part, the borrower may appeal the decision to the SBA.
For various reasons, certain taxpayers that borrowed funds under the PPP may not have their loan forgiveness approved by December 31, 2020, and in some cases, borrowers may decide to wait until 2021 to submit a loan forgiveness application with the thought that if they wait the forgiveness will not impact their 2020 tax filings. Clearly, the most recent positions taken by the IRS indicate that the tax impact will still be on the 2020 tax returns
Revenue Procedure 2020-51 Gives Some, But Not Much, Relief
Revenue Procedure 2020-51 offers guidance for businesses who reasonably believe that they met the criteria for forgiveness at the end of 2020, but whose loans are not in fact forgiven in a later year because the bank says “no” or the taxpayer decides, for whatever reason, not to apply for forgiveness and agrees to repay the PPP loan. The IRS gives the business three choices: (1) claim the deductions on their tax return for 2020 if it is filed timely (taking extensions into account); (2) claim the deductions on an amended tax return for 2020; or (3) claim the deductions on the tax return for the later year in which it becomes clear that the loan will not be forgiven. Revenue Procedure 2020-51 goes through the procedural requirements for this relief, including the type of notice to be attached to the tax return so that the IRS understands that the taxpayer is relying on Revenue Procedure 2020-51.
Revenue Ruling 2020-27 does not distinguish between PPP loans that are above or below $2 million. Accordingly, a broad reading of the ruling would suggest that the IRS intended for the disallowance of expenses in the year paid or incurred to apply generally to taxpayers with PPP loans of any amount, provided that such taxpayers (1) paid or incurred eligible expenses within the covered period, and (2) submitted an application for loan forgiveness by year-end, or intend to do so after year-end. As such, absent any legislation that would effectively overturn Notice 2020-32 and Revenue Ruling 2020-27, it is likely that taxpayers seeking to deduct PPP-eligible expenses on their 2020 return will face challenges from the IRS upon examination of their tax returns.
It is possible that Congress could overturn the IRS notice and revenue ruling through subsequent legislation, however, given all that is going on, the odds of this happening are slim.
Lastly, be aware that every business is required to keep all documentation related to the PPP loan and any forgiveness for a period of six years beyond the date of forgiveness being granted or loan being repaid.
At Hall & Company, we are here to help you navigate through the PPP Loan Forgiveness process. Please give us a call at (949) 910-4255 with any questions.
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