PPP Loan Update: Tax Treatment and Deductibility of Expenses

The most frequent question we were asked this month was about tax treatment of PPP loans. How do businesses treat these expenses? Are they deductible? What about the timing and recognition? What if we apply for forgiveness and are denied after filing 2020 taxes?

  To answer, let’s first review the history of conversation around PPP loan forgiveness and tax treatment:

1. The CARES Act (P.L. 116-136), passed on March 27, 2020, held that debt cancellation income which would otherwise be included gross income (IRC §108(a)) shall be excluded for purposes of certain paycheck protection program loans (§1102 and §1106 of CARES Act). Generally good news, right?
2. Next, the IRS released Notice 2020-32, which denies tax deductions for amounts paid under the PPP which were forgiven, citing this treatment as being necessary to prevent taxpayers from receiving double benefit. If taxpayers are not able to deduct certain amounts paid through PPP funds, won’t that accelerate income recognition? Yes, but only if the intention was to pay those expenses without regard to qualifying for a PPP loan.
3. In protest of this, on August 4, 2020, the AICPA and 170 other organizations issued a letter to Congress to request a technical correction to the IRS notice, citing that congressional intention was inconsistent with IRS treatment and therefore deductions for expenses paid with PPP loan proceeds should be allowed. Ultimately, the IRS did not budge.
4. On November 18, 2020, the IRS released guidance in the form of a Revenue Ruling (2020-27), where they reasserted the position that taxpayers cannot claim a deduction for expenses paid with forgiven PPP funds. This guidance relies on §1.265-1 of the Treasury Regulations, which states that “no deduction is allowed for any amount otherwise allowable as a deduction to the extent the amount is allocable to one or more classes of income other than interest wholly exempt from the taxes.”

All of that transpired over the last eight months, and we are still in the same position? Not quite. The IRS also issued guidance under Rev. Proc. 2020-51, providing a safe harbor for taxpayers who prefer to deduct such expenses by irrevocably deciding not to seek forgiveness. This is done by filing an election under the same Revenue Procedure along with your timely filed tax return, including extensions. It also provided clarity for those who are denied forgiveness after filing their 2020 tax returns. In short, taxpayers can file an amendment to recognize those deductions in the 2020 tax year. Bottom line: taxpayers can no longer deduct expenses in 2020 and later seek forgiveness. We’re expecting that most of our clients will seek forgiveness and therefore forgo the deduction, as the value of the cash is more valuable than the potential tax benefit. But taxpayers should make their decision based on their own cash flow needs. We’re encouraging clients to make their decision by the end of year, for tax planning purposes – or at least by 4/15/21, when taxes are owed.   To help you determine the best approach for your business, please reach out to us at [email protected].