As we previously wrote, the IRS announced earlier this year (via Notice 2020-32) that forgivable costs pursuant to a PPP loan would not be deductible for federal tax purposes. While there has been strong opposition to Notice 2020-32, PPP borrowers are advised to comply with its absent substantial authority to take a different position. Applying Notice 2020-32 is not so straight forward, however, given that most PPP borrowers won’t know if their forgiveness application has been approved by the SBA until after the end of the 2020 tax year. This left taxpayers to ponder how to account for the PPP loan on their 2020 income tax returns. Such returns are not only confined to calendar year 2020 taxpayers, but also includes any tax year in which PPP related expenses have been paid.
But ponder no more, as the IRS issued guidance on November 18, 2020, in the form of a Revenue Ruling (Revenue Ruling 2020-27) that clarifies how PPP borrowers should treat forgivable costs on their federal tax returns. In short, PPP borrowers should not deduct forgivable costs on their federal income tax returns if, at the end of the tax year, they reasonably expect to receive forgiveness of the PPP loan. This is true even for taxpayers that have not submitted their PPP forgiveness application by the end of their tax year but plan to do so in a subsequent tax year.
Example 1: Calendar year taxpayer received a PPP loan of $250,000 and the 24-week testing period ended October 31, 2020. After going thru the forgiveness calculation, the taxpayer determined that $225,000 of the loan would be eligible for forgiveness. On its tax return, the taxpayer must reduce the otherwise deductible expenses by $225,000.
Example 2: Same facts as Example 1 except the taxpayer’s year ended September 30, 2020. The taxpayer determined that of the expenses eligible for forgiveness, $210,000 were paid in the 9/30/2020 year and $15,000 were paid in the 9/30/2021 year. The expenses for each of these years must be reduced by the amounts identified as belonging to each fiscal year.
Additionally, the IRS issued Rev. Proc. 2020-51 which provides a safe harbor allowing taxpayers to claim a deduction against their taxable income for non-deducted eligible expenses in the event that forgiveness is denied or the taxpayer ultimately does not apply for forgiveness. Essentially, if a taxpayer previously did not deduct eligible expenses (non-deducted eligible expenses), Rev. Proc. 2020-51 allows the taxpayer to either file an amended return to claim the deductions or to claim the deductions in a subsequent taxable year. In the case of a partnership which has not elected out of the centralized partnership audit regime (BBA), the prior year return is corrected via an Administrative Adjustment Request (AAR).
Example 3: Same facts as Example 1, but only $125,000 of the loan is forgiven. Thus, the taxpayer would have been able to deduct $100,000 more expenses than anticipated. The taxpayer may choose to claim a deduction for $100,000 of expenses by either filing a 2020 amended return (or AAR in the case of a BBA partnership) or by deducting the expenses on the 2021 return.
Rev. Proc. 2020-51 does present an opportunity for taxpayers in this situation to pick the tax year that results in the most savings for the newfound deduction.