The CARES Act clearly states that a forgiven PPP Loan would not be treated as taxable income. However, it did not specify if the eligible expenses would be deductible. In April, the IRS issued Notice 2020-32 taking the position that these expenses would not be deductible. The Notice did not address how a taxpayer would report these non-deductible expenses if they were incurred in one tax year and loan forgiveness occurred in a subsequent tax year.
On November 18, the IRS issued Revenue Ruling 2020-27 that offered guidance to resolve the above question. The ruling provides that at year-end if a taxpayer has a “reasonable expectation” of forgiveness the eligible expenses cannot be deducted. A “reasonable expectation” is not defined but it appears that a taxpayer that has incurred sufficient expenses in compliance with the requirements of the CARES Act would have a reasonable expectation of forgiveness. This would also be true even if an application for forgiveness had not yet been submitted to their lender at year-end. As a result, calendar-year entities would need to treat eligible expenses as nondeductible in 2020.
The Revenue Ruling does not address taxpayers having fiscal years ending in 2020 that would have eligible expenses incurred over two fiscal years. It appears that expenses would be nondeductible during both fiscal years to the extent eligible expenses are incurred each year.
In conjunction with the above Revenue Ruling, the IRS also released Revenue Procedure 2020-51 which contains reporting guidance for taxpayers treating their PPP loan as debt to be repaid or having their forgiveness request denied or reduced. Taxpayers not requesting forgiveness can deduct their eligible expenses on their 2020 return. Taxpayers having their forgiveness request denied or reduced can deduct eligible expenses on their 2020 return or the return for the year in which their forgiveness amount was determined.
Additional guidance is expected regarding the impact that nondeductible expenses will have on other tax provisions. For example, wages used to calculate the R&D credit or the Qualified Business Income deduction for owners of pass-through entities would likely be reduced. Based on these uncertainties, borrowers may consider calculating forgiveness based on all eligible expenses rather than solely on payroll costs.
There is currently legislation pending in Congress that would allow taxpayers to deduct expenses paid with PPP funds. There is also support in Congress for overturning the IRS’s position. Yesterday, in reaction to the IRS’s latest ruling, Senate Finance Committee Chairman Chuck Grassley issued a bipartisan statement sharply criticizing the guidance. If Congress enacts legislation to resolve this issue the guidance discussed above will become irrelevant.
Due to the many uncertainties previously discussed, you may want to consider delaying the submission of your forgiveness application until more guidance has been issued or new legislation has been enacted. Since there are many unanswered questions and planning opportunities available contact your ASL engagement partner to further discuss your PPP loan.