The Internal Revenue Service (the “IRS”) set forth its position on the treatment of expenses incurred, and paid for, with the use of the proceeds from the Paycheck Protection Program (the “PPP Loan”) in IRS Notice 2020-32 (the “Notice”). In such Notice, the IRS attempted to provide guidance regarding the deductibility for Federal income tax purposes of certain otherwise deductible expenses incurred in a taxpayer’s trade or business when the taxpayer receives a loan pursuant to the Paycheck Protection Program.
Pursuant to Section 1102 of the CARES Act, a recipient of a covered loan should use the proceeds of the PPP Loan to pay “Qualified Expenses.”1
Contrary to Congressional intent, the Notice from the IRS states that no deduction is allowed under the Internal Revenue Code (the “Code”) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to Section 1106(b) of CARES Act, and that the income associated with the forgiveness is excluded from gross income pursuant to section 1106(i) of the CARES Act.
This Notice from the IRS has created a great deal of uncertainty as to whether Qualified Expenses paid for with PPP Loan proceeds will be permitted to be deducted in 2020, and whether the disallowance of the Qualified Expenses could be deferred until the 2021 tax year when the PPP Loan may be actually forgiven.
From our experience, many clients and professionals were planning to wait until 2021 to apply for PPP Loan forgiveness in hopes to defer the application of the Notice, and delay when the Qualified Expenses would be disallowed and added back to taxable income.
The IRS has put an end to this speculation with its publication of Revenue Ruling 2020-27 (the “Revenue Ruling”). The Revenue Ruling explicitly states that any taxpayer that is a recipient of a PPP Loan, who reasonably expects that its PPP Loan will be forgiven, may not deduct the Qualified Expenses paid for with the proceeds of the PPP Loan on the taxpayer’s 2020 income tax return, regardless of when the taxpayer applies for PPP Loan forgiveness and regardless of when the PPP Loan is actually forgiven.
In Revenue Procedure 2020-51, the IRS provides a safe harbor for taxpayers who do not take the tax deductions for Qualified Expenses in tax year 2020, and subsequently do not apply for PPP Loan forgiveness or have their PPP Loans only partially forgiven, or not forgiven at all. However, it is clear from the Revenue Ruling that these Qualified Expenses will not be deductible in 2020 if the taxpayer has a reasonable expectation that the PPP Loan will be forgiven.
Proper year-end tax planning has to be thought out when calculating taxable income of a business for 2020, and in turn what estimated tax payments need to be made for the business, or if a pass-through entity, for the shareholders, partners or owners of said business.
Please contact us at Morella & Associates (412-369-9696) to discuss year-end tax planning and any questions you may have regarding this recent IRS guidance.
1 Qualified Expenses include (1) payroll costs, (2) certain employee benefits relating to healthcare, (3) interest on mortgage obligations, (4) rent, (5) utilities, and (6) interest on any other existing debt obligations.