IRS Provides Further Guidance on the Deductibility of Expenses Funded by PPP Loans

The Internal Revenue Service recently released Revenue Ruling 2020-27 and Revenue Procedure 2020-51, which provide guidance on the deductibility of certain expenses paid or incurred in a taxpayer’s business using loan proceeds from a “covered loan” provided under the CARES Act’s Paycheck Protection Program.

Under the CARES Act, the principal amount of a covered loan that is used to pay eligible expenses during 2020 may be forgiven to the extent of the eligible expenses, and the amount forgiven is not treated as gross income for the borrower. Very generally, Revenue Ruling 2020-27 confirms that a borrower may not deduct an otherwise deductible expense in its 2020 taxable year if, at the end of the 2020 taxable year, the borrower reasonably expects to be reimbursed for those expenses as a result of forgiveness of a covered loan, even if the borrower has not yet submitted an application for forgiveness of the covered loan. Revenue Procedure 2020-51 provides safe harbors that allow borrowers to take deductions for certain expenses paid for or incurred with proceeds from a covered loan when it is understood that all or part of the covered loan will not be forgiven.

For more information on Paycheck Protection Program (PPP) loan forgiveness and the application for forgiveness, read our LawFlash, CARES ACT: Paycheck Protection Program Provides Small Business Loans to Support Employees.

Revenue Ruling 2020-27

Amplifying guidance provided in Internal Revenue Service (IRS) Notice 2020-32, discussed in our May 6, 2020 LawFlash, Revenue Ruling 2020-27 considers two scenarios involving a borrower that is a calendar year taxpayer that received a covered loan under the PPP. In both scenarios, the borrower pays during its 2020 tax year certain payroll costs, mortgage interest, utility payments, and rents that are treated as “eligible expenses” under the CARES Act. In the first scenario, the borrower applies for forgiveness of the loan in November 2020, but the borrower does not receive confirmation before the end of 2020 that the loan will, in fact, be forgiven. In the second scenario, the borrower does not apply for forgiveness of the loan in 2020, but expects to apply for forgiveness in 2021. In both scenarios, the amount of eligible expenses is known and the borrower has a reasonable expectation that the loan will ultimately be forgiven. Revenue Ruling 2020-27 holds that under either of the above scenarios, the borrower may not deduct the eligible expenses in computing its taxable income for the 2020 tax year if, at the end of the tax year, the borrower reasonably expects to receive forgiveness of the covered loan.

The two scenarios in the ruling also illustrate the IRS’s position that a borrower should be considered to have a reasonable expectation of forgiveness if it used the proceeds from a covered loan for eligible expenses described in the CARES Act and otherwise satisfied the requirements under the CARES Act for forgiveness, due to the presence of “clear and readily accessible guidance to apply for and receive covered loan forgiveness.”

Revenue Procedure 2020-51

Revenue Procedure 2020-51 provides a safe harbor for certain borrowers that are partially or fully denied forgiveness of a covered loan and borrowers that never make a claim for forgiveness of a covered loan (or withdraw a claim), including borrowers that had previously reasonably expected to receive forgiveness of a covered loan.

Specifically, under the safe harbor a borrower may claim a deduction in the borrower’s taxable year beginning or ending in 2020 (the 2020 taxable year), or a subsequent taxable year, for certain otherwise deductible eligible expenses if all of the following occur:

1. The borrower received a covered loan used to pay eligible expenses.
2. The eligible expenses are paid or incurred during the borrower’s 2020 taxable year, and no deduction was permitted for those expenses because the borrower reasonably expected forgiveness of the covered loan.
3. The borrower submitted before the end of the 2020 taxable year, or as of the end of the 2020 taxable year intends to submit in a subsequent taxable year, an application to have the covered loan forgiven.
4. In a subsequent taxable year, the borrower’s request for forgiveness of the covered loan is denied (either in whole or in part), or the borrower decides never to request forgiveness of the covered loan (or withdraws a request for forgiveness).

If a borrower meets the above requirements, it may be able to deduct some or all of the eligible expenses on (1) the borrower’s timely filed, including extensions, original income tax or information return for the 2020 taxable year; (2) an amended return or an administrative adjustment request (AAR) under Section 6227 for the 2020 taxable year; or (3) the borrower’s timely filed, including extensions, original income tax or information return for the subsequent tax year.

A borrower may not apply the safe harbor procedures to deduct any amount of non-deducted eligible expenses unless the borrower attaches a statement to the return on which the borrower deducts non-deducted eligible expenses. The statement must be titled “Revenue Procedure 2020-51 Statement,” and must include the information outlined in the revenue procedure.

The flexibility to deduct certain expenses in a subsequent tax year under the safe harbor may be helpful to certain borrowers that may not need the benefit of the deduction in the 2020 taxable year.

Observations

• Consistent with Notice 2020-32, the IRS’s conclusions in Revenue Ruling 2020-27 and Revenue Procedure 2020-51 are at odds with the intended policy objectives of the PPP-related provisions in the CARES Act as articulated by lawmakers, including Senate Finance Committee Chairman Chuck Grassley (R-Iowa) and Ranking Member Ron Wyden (D-Ore.).
• Numerous parties are urging Congress to enact legislation before the end of 2020 that includes a technical correction addressing the tax treatment of PPP loan forgiveness and several lawmakers have pledged that the next round of COVID-19-related relief legislation will contain such a provision.
• If Congress does not address the deductibility of expenses funded through a PPP loan before March 2021, taxpayers may wish to consider whether it would be appropriate to file an extension request for their 2020 income tax returns. This will provide additional time for taxpayers to file their tax returns and recompute their tax liabilities, including the impact that a taxpayer’s wage expense has on Section 199A deductions and R&D credits, if needed, based on Congress’s action or inaction.

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Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Boston
Daniel A. Nelson
George P. Mair
Meghan McCarthy

New York
Richard S. Zarin

Philadelphia
Andrew T. Budreika
Daniel F. Carmody
Benjamin W. Stango

Silicon Valley
Barton W.S. Bassett

Washington, DC
Jennifer Breen
James G. Steele III
Jonathan Zimmerman