Taxes: Paycheck Protection Program Loan DeductionsBy
Rather than file an amended 2020 tax return, some small businesses may be able to deduct in 2021 eligible business expenses that were paid or incurred in 2020 and related to a Paycheck Protection Program loan.
The Paycheck Protection Program (PPP) was established in 2020 by §1102 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to assist businesses during the COVID-19 pandemic. Under the PPP, a recipient of a covered loan may use the proceeds to pay payroll costs; certain employee benefits relating to healthcare, rent, and utilities; and interest on mortgage obligations or any other existing debt obligations. Section 1106 of the CARES Act, later amended by the Paycheck Protection Program Flexibility Act of 2020, further provided that a recipient of a covered loan can receive forgiveness of indebtedness on the loan. In other words, businesses that received a PPP loan and later applied for loan forgiveness may not be required to pay back part or all of the loan, depending on what the loan was used for and other loan forgiveness terms, such as maintaining employee and compensation levels.
The forgiveness is limited to the sum of payments made during the “covered period” beginning on the loan’s origination date and ending 24 weeks after the date of origination or December 31, 2020—whichever comes first—for payroll costs, any payment of interest on any covered mortgage obligation, any payment on any covered rent obligation, and any covered utility payment.
In response to §1106 of the CARES Act, the U.S. Department of the Treasury issued Notice 2020-32 (2020-21 IRB 837) on May 18, 2020, and held that no deduction is allowed under the Internal Revenue Code for an expense that results in forgiveness of a covered loan under PPP. The ruling—to prevent a double tax benefit—essentially dismisses the deductibility of the expense since it’s related to the forgiveness of the loan amount that’s excluded from gross income and thus considered tax-exempt income.
To provide clarification, the Internal Revenue Service (IRS) issued Notice 2020-32 (Rev. Rul. 2020-27) on November 19, 2020. This ruling held that taxpayers receiving covered loans guaranteed through the PPP may not deduct the associated expenses in the tax year when those expenses were paid or incurred if the taxpayer reasonably expects to receive or actually received forgiveness of the covered loan in the following taxable year. This nondeductibility of those expenses applies even if the taxpayer hasn’t submitted an application for forgiveness of the covered loan by the end of the taxable year.
Senators Chuck Grassley (R.-Iowa), chairman of the U.S. Senate Committee on Finance, and Ron Wyden (D.-Ore.), the ranking Democrat on the Committee, were so disappointed with this guidance that they released a joint statement—unusual coming from both sides of the aisle—expressing disappointment and noting that the Treasury Department’s position on the PPP loan expense deductibility ran counter to their intention when crafting the legislation.
Although Congress may have intended to permit businesses to deduct the expenses associated with the covered loan forgiveness legislation, the CARES Act doesn’t state or imply this intention. Thus, Congress had to amend the legislation itself so that the expenses associated with nontaxable PPP loan forgiveness would be deductible, which it did in §276 of the COVID-related Tax Relief Act of 2020 (Subtitle B of the Consolidated Appropriations Act, 2021).
For taxpayers whose PPP loans are forgiven, no deduction would be denied for expenses paid with the proceeds of a PPP loan, no tax basis increase would be denied (otherwise the tax basis would be reduced for nondeductible expenses), and no tax attribute would be reduced because of the loan forgiveness.
Section 276 is effective retroactively for taxable years ending after the date of the enactment of the CARES Act, which was passed on March 27, 2020. Calendar-year taxpayers can deduct the applicable expenses associated with the PPP-forgiven loans when they file their 2020 tax return. But those who aren’t calendar-year taxpayers would have followed the guidance of Rev. Rul. 2020-27 and not deducted those expenses.
SAFE HARBOR PROVISION
To address this situation, the Treasury Department issued Rev. Proc. 2021-20 on April 22, 2021, to provide a safe harbor provision. The covered taxpayers may deduct these expenses on their timely filed federal income tax return or information return, as applicable, in their 2021 taxable year rather than filing an amended return or administrative adjustment request for their 2020 taxable year.
To take advantage of this safe harbor provision, a taxpayer must be a “covered taxpayer,” which means the taxpayer must satisfy all the following:
1. Received an original PPP covered loan,
2. Paid or incurred original eligible expenses during the taxpayer’s 2020 taxable year,
3. Timely filed, including extensions, a federal income tax return or information return, as applicable, for the taxpayer’s 2020 taxable year on or before December 27, 2020, and
4. Didn’t deduct on their federal income tax return or information return, as applicable, the original eligible expenses because (a) the expenses resulted in forgiveness of the original PPP covered loan; or (b) they reasonably expected that the expenses would result in such forgiveness at the end of the 2020 taxable year.
In addition, a taxpayer must make a valid election to apply the safe harbor provisions in Rev. Proc. 2021-20 by attaching a statement to their timely filed—including extensions—federal income tax return. The attached statement must be titled “Revenue Procedure 2021-20 Statement” (and named RevProc2021-20.pdf for e-file attachments) and include the following:
1. The taxpayer’s name, address, and Social Security number or taxpayer identification number;
2. A statement that the taxpayer is applying the safe harbor provision provided by §3.01 of Rev. Proc. 2021-20;
3. The amount and date of disbursement of the taxpayer’s original PPP covered loan; and
4. A list, including descriptions and amounts, of the original eligible expenses paid or incurred by the taxpayer during the 2020 taxable year that were not reported on the 2020 taxable year return but will be reported on the federal income tax return or information return, as applicable, for the taxpayer’s first taxable year following that 2020 taxable year, which should be the 2021 taxable year return.
This list is necessary because it’s unusual for a taxpayer to be able to deduct expenses in a year other than the year of actually being paid or incurred.
Rev. Proc. 2021-20 also provides some limitations to the safe harbor. The IRS reserves the right to examine any issues relating to the claimed deductions for original eligible expenses, including determining whether a taxpayer is a covered taxpayer under the revenue procedure, the amount of the deduction, and whether the covered taxpayer has substantiated the deduction claim.
In addition, the IRS can request additional information or documentation verifying any amounts described in the statement.
© 2021 A.P. Curatola