by Scott Lewis, CPA, MSA
The Paycheck Protection Program (PPP) loans were created and signed into law to provide relief to small businesses during the coronavirus pandemic as part of the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act, back in March of 2020. They were designed as an assistance measure in these times of unprecedented economic uncertainties in the United States.
As part of the CARES Act under section 1106(b), recipients of these loans could receive full or partial forgiveness on this debt for payments made for the following expenses: payroll and salary costs; interest on any covered mortgage obligations; payments on any covered rent obligations; and any covered utility payments. The rules and guidelines for these loans were adjusted frequently throughout the year, including the applicable covered time periods of the loan and the percentage of use allowed for salaries vs. other expenses. What did not change was that the act specifically exempted all loan amounts that were to be forgiven from gross taxable income.
In early May 2020 the IRS issued Notice 2020-32, stating that although the forgiveness amounts were to be treated as tax exempt income, the above expenses up to the amount of forgiveness would be disallowed as these are allocable to the tax-exempt income. The authority cited by the IRS on this Notice comes from Internal Revenue Code §265 (a)(1). This disallows any otherwise allowable deductions under any provision of the Code, including section 162 (Trade or Business expenses), and section 163 (Interest), for any payment of an eligible section 1106 expense. Otherwise there would be a double tax benefit, tax-exempt debt forgiveness income and allowable payroll and other covered expense tax deductions.
Senior members of Congress agree that the interpretation from the IRS creates an unfair burden on already struggling businesses. Both houses of Congress have introduced bipartisan bills to overturn this position of the IRS. Leaders of the tax-writing Senate Finance Committee, Chuck Grassley, an Iowa Republican, and Ron Wyden, an Oregon Democrat, have asked the IRS and Treasury to reconsider their position and said Congress may act as it reconvenes in December.
“Since the CARES Act, we’ve stressed that our intent was for small businesses receiving Paycheck Protection Program loans to receive the benefit of their deductions for ordinary and necessary business expenses,” the senators said in a statement.
The American Institute of Certified Public Accountants (AICPA) believes that this interpretation by the IRS is contrary to the intent of Congress and has continually advocated for legislation that would clarify that PPP loan forgiveness should not affect the deductibility of otherwise ordinary business expenses. On December 3rd, they, along with several hundred trade associations, and other groups, formally issued a letter to the leaders of both houses of Congress appealing them to pass legislation this year which reverses this treatment of these expenses by the IRS
Amongst this uncertainty and to further clarify their position, the IRS recently issued additional guidance on how to report PPP loan forgiveness. IRS Revenue Ruling 2020-27 states that if it is reasonably expected that all PPP loan proceeds will be forgiven, whether it be in 2020 or 2021, regardless of the timing of loan forgiveness applications or formal notifications from lenders, this must be taken into taxable income, via disallowance of the salaries and other expenses paid by the loan proceeds in 2020.
A safe harbor under Revenue Procedure 2020-51 was also issued. All expected loan forgiveness would need to be reported in 2020. Any disallowed portion of this loan forgiveness, if applicable, can be expensed/deducted in a future tax filing. This safe harbor can be accomplished through several ways. They can be expensed on the filed income tax return in a year after the 2020 taxable year, file an amended 2020 income tax return, or on the timely filed (including extensions) original tax return for 2020 assuming all facts and circumstances are known. A statement is required for the safe harbor should the taxpayer need to use this IRS revenue procedure. To qualify for the safe harbor, the taxpayer must attach a statement to their return titled “Revenue Procedure 2020-51 Statement” that contains pertinent information such as the amount of the loans, amount forgiven/not forgiven, and the amounts of expenses being deducted.
To summarize for the tax year 2020, unless Congress reverses the positions of the IRS, all otherwise allowable expenses such as salaries and mortgage interest paid by the PPP forgivable loan proceeds will not be tax deductible. Please consider this in any final income tax planning and projections as we approach the end of the year.