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IRS Issues Further Clarification on Deductibility of Expenses Paid with Forgiven PPP Loans

Services: Tax

By: Kim Kamens

The week before Thanksgiving the IRS released long-awaited guidance regarding the tax treatment of expenses paid with PPP loan funds.  While we were all hoping for a reversal of IRS Notice 2020-32 released on May 2, 2020 on this topic.  Unfortunately that was not the case.

The IRS issued a Revenue Ruling and a Revenue Procedure regarding the tax treatment of these expenses:

Rev. Rul. 2020-27:

The Ruling provides two example situations:  One in which the taxpayer applied for PPP loan forgiveness by the end of 2020, and the other in which the taxpayer had not yet applied as of the end of 2020 but plans to in 2021.  In both cases the taxpayers have a reasonable expectation of reimbursement (i.e. forgiveness). 

In both cases, the Revenue Ruling states that the eligible expenses will not be allowed as a tax deduction in tax year 2020.  The fact that forgiveness was reasonably expected in both situations precludes the deduction of the applicable expenses, regardless of the time for filing the forgiveness application. The IRS has determined that the reimbursement, forgiveness, was foreseeable.

In the case of a sole proprietor whose eligible “expenses” include his/her profit draws, there would be no taxable impact with regard to the portion of the forgiven loan used to pay the draws.  The loan forgiveness itself is not taxable, and because a sole proprietor’s draws are never a deductible expense, they are not impacted by the forgiveness. The loan was considered “owner compensation replacement.” If the entire amount of the PPP loan exceeds owner compensation replacement computed based on the 8 or 24 week forgiveness period, the balance of the funds had to be spent on utilities, rent or mortgage in order to be fully forgiven. Those expenses would not be deductible. This would also apply in the case of partner draws from a partnership.  However, if partners receive “guaranteed payments” from their partnership, which are normally deducted at the company level, these would not be deductible to the extent they are included in the forgiven expenses.

Rev. Proc. 2020-51: 

This Procedure provides a safe harbor whereby a taxpayer that paid or incurred eligible expenses during the taxpayer’s 2020 taxable year, received a PPP loan which it expected to be forgiven in a subsequent taxable year.  If the loan was in fact not forgiven, either in whole or in part, the taxpayer is able to deduct some or all of the eligible expenses.  The deduction is allowed on the taxpayer’s original 2020 tax return, an amended 2020 tax return, an administrative adjustment request as applicable, or a subsequent year tax return.

Note that this treatment is also allowable in the event the taxpayer irrevocably decides in a subsequent tax year that it will not apply for covered loan forgiveness.

Further details are included in the Rev. Proc., including a required statement to be included with the tax return. The statement must be titled “Revenue Procedure 2020-51 Statement."