Government Contracting
IRS Further Clarifies Tax Treatment of Expenses Covered by PPP Loans
On November 18, 2020 the Internal Revenue Service (IRS) released a Revenue Ruling (Rev. Rul. 2020-27) and a Revenue Procedure (Rev. Proc. 2020-51) that discuss the handling of deductions for expenses paid with forgivable Paycheck Protection Program (PPP) loan proceeds in circumstances when either: (i) forgiveness has been applied for, but not granted by the end of 2020, or (ii) forgiveness has not been applied for, but all events have been met to give rise to a forgiveness application in 2021 for expenses paid with PPP funds in 2020.
This new guidance comes after the IRS, in April, issued Notice 2020-32, which stated that no deduction would be allowed for expenses paid with PPP loan funds to the extent those expenses are associated with forgiveness of the PPP loan. While the Small Business Administration (SBA) has begun to process PPP loan forgiveness applications, many PPP loan borrowers are unlikely to receive confirmation of loan forgiveness (either wholly or partially) until 2021. Additionally, some borrowers who otherwise have met the criteria for forgiveness in 2020 will not file forgiveness applications until early 2021. Because of these timing issues, there had been some uncertainty as to whether PPP loan borrowers in these positions would be entitled to take deductions for expenses paid with forgivable PPP loan funds in 2020, if forgiveness is not actually granted until 2021. The newly issued Revenue Ruling and Revenue Procedure clarify these points.
Rev. Rul. 2020-27 stands for the general rule that if all events are fixed for forgiveness at the end of 2020, and forgiveness is reasonably anticipated, expenses supporting the forgiveness application are NOT deductible by the taxpayer in 2020, even if forgiveness is not actually received until 2021. This is the case where forgiveness has been applied for in 2020, but is not granted until after the end of the year, and where forgiveness has not been applied for in 2020, but the criteria for forgiveness are met in 2020, and the taxpayer intends to apply for forgiveness in early 2021. Rev. Proc. 2020-51 contains a safe harbor procedure pursuant to which taxpayers who are denied (wholly or partly) forgiveness or who elect not to apply for forgiveness can claim the deductions for these expenses either on their originally filed 2020 return or in an amended return (as applicable, depending on timing).
The practical effect of Rev. Rul. 2020-27 for PPP borrowers who have applied for or are planning to apply for forgiveness is that these taxpayers will not be allowed deductions for expenses supporting forgiveness even if forgiveness remains uncertain. For many taxpayers, this will result in 2020 taxable income in excess of what they previously anticipated. All businesses in this situation should consult with their tax professionals in order to determine whether any yearend planning steps can be taken now to increase other deductible expenses or otherwise work to reduce 2020 taxable income.
This will be of particular importance for professional and service businesses that operate as cash-basis C corporations. Because these entities generally seek to zero out corporate level income at year end through employee bonus and other expense payments these entities should engage in planning to ensure that sufficient deductible expenses are paid in 2020 to zero out corporate level income, create a loss or at least mitigate the impact of this unanticipated taxable income. It is important to recognize that an operating loss in 2020 can be carried forward to 2021, but a loss in 2021 can no longer be carried back to 2020. So, incurring corporate taxable income in 2020, with a corresponding taxable loss in 2021, would be a sub-optimal result that may be avoided by some tax planning with respect to the payment of bonuses and other expenses before 2020 year end.
If your business is in this situation, you should not delay in seeking tax advice regarding yearend planning options in light of this new IRS guidance.
Any opinions expressed and any legal positions asserted in the article are those of the author(s) and do not necessarily reflect the opinions or positions of Miles & Stockbridge P.C. or its other lawyers. This article is for general information purposes and is not intended to be and should not be taken as legal advice on any particular matter. It is not intended to and does not create any attorney-client relationship. Because legal advice must vary with individual circumstances, do not act or refrain from acting on the basis of this article without consulting professional legal counsel. If you would like additional information on the subject matter of this article, please feel free to contact any of the lawyers listed above. If you communicate with us, whether through email or other means, your communication does not establish an attorney-client relationship with either Miles & Stockbridge P.C. or any of the firm's lawyers. At Miles & Stockbridge P.C., an attorney-client relationship can be formed only by personal contact with an individual lawyer, not by email, and requires our agreement to act as your legal counsel together with your execution of a written engagement agreement with Miles & Stockbridge P.C.
