IRS Clarifies PPP Related Expense Deductions
Back on April 30, 2020, the IRS issued Notice 2020-32, which clarified business expense deductions are disallowed when they are funded by PPP loans that are forgiven. This guidance appeared to go against the intent of the CARES Act based on how numerous members of Congress responded. For most of the rest of 2020, deductibility of PPP related expenses was not discussed as the focus was on business operations and spending PPP loan monies properly.
On November 18, 2020, the IRS issued Revenue Ruling 2020-27 and Revenue Procedure 2020-51. The guidance generally disallows deductions in the tax year in which the expenses are paid or incurred if loan forgiveness is reasonably expected to occur, regardless of when forgiveness is granted.
So what does reasonably expected mean? Reasonably expected is determined based on the expenses paid or incurred during the covered period. Borrowers will know the amount of their PPP loan and they will also know how much of the PPP loan has been spent during their covered period. Given those two items, borrowers should have a reasonable expectation related to loan forgiveness in 2020. Actually filing or forgiveness has no impact on the reasonable expectation test. Below is directly from the revenue ruling:
A taxpayer that received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.
It seems likely that many PPP borrowers will have spent 100% of their PPP funds during their covered period. The change from an 8-week to a 24-week covered period ensured that for many borrowers. This fact, given the current guidance, means that expenses paid with PPP funds should not be deducted.
Members of Congress have come out publicly disagreeing with the new guidance released by the IRS. Many members of Congress have maintained that the intent of the CARES Act was to ensure that forgiveness of a PPP loan would not create taxable income AND expenses paid with PPP loan monies would be deductible for income tax purposes. Unfortunately, legislative action on this has yet to take place.
Given the new guidance and the uncertainty in Congress, we strongly recommend talking to your tax preparer about your specific circumstances and what you should be doing now to prepare for your 2020 tax filings.