The IRS and the Treasury Department recently provided additional guidance which may result in higher taxes for Payroll Protection Program (PPP) loan recipients. As part of the pandemic relief provided last summer, the U.S. government created a forgivable PPP loan program to help struggling businesses make certain payroll, mortgage interest, utility, and rent payments.
On November 18, 2020, the IRS provided additional clarification that expenses paid using the PPP program will not be deductible if the underlying loan is forgiven. As put forth in Revenue Ruling 2020-27, the IRS position states that a taxpayer may not claim a deduction for any otherwise deductible expense if the payment of the expense results in forgiveness of a PPP loan. This is because the income associated with forgiveness is excluded from gross income. The latest guidance from the IRS and Treasury remains consistent with their initial position in Notice 2020-32, released earlier this year, that also stated otherwise eligible expenses are not deductible if the payment results in forgiveness of the PPP loan.
Taxpayers who were expecting to deduct eligible PPP expenses may be in for an unpleasant surprise when calculating their 2020 taxes. To add to the confusion surrounding this issue, businesses organized as separate entities, such as S-Corps or partnerships, may be more affected than sole proprietorships or disregarded entities, like single-member LLCs. Additional consideration should also be given to the potential impact on NOL carrybacks. Finally, the ordering rule for the non-deductibility of expenses where the PPP loan is only partially forgiven may also impact other key tax provisions, a few examples being the Section 199A qualified business income deduction as well as research and development credits.
Many practitioners believe the current IRS and Treasury position contradicts Congress’ intent when it enacted the PPP loan forgiveness program as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. In fact, the CARES act does not specifically address the deductibility of expenses paid with PPP proceeds. The current position of the IRS and Treasury has led to some backlash from Congress as well, with Senator Chuck Grassley and Representative Richard Neal writing to the Treasury Secretary, Steve Mnuchin. Grassley and Neal oversaw their respective Senate and House committees which drafted the CARES act initially, and they are well-placed to provide the Treasury Department with insight regarding Congress’ intent.
Grassley and Neal informed Secretary Mnuchin that the PPP loan was always intended to be a tax-free grant, meaning it should have no impact on the deductibility of business expenses. Moreover, both the House and the Senate have included language making expenses paid with PPP forgiven monies tax-deductible in the new COVID relief legislation currently being negotiated. Despite protests from Congress and the likelihood that this may be remedied with a subsequent relief bill, the IRS and Treasury have not retreated from their current position.
Even though this issue may be solved with future legislation, or even ultimately litigated in the courts, if you received a PPP loan you should not expect to currently deduct any expenses which were paid with your PPP loan proceeds, even if you have not yet received or applied for PPP loan forgiveness. If you are denied loan forgiveness in whole or in part, or irrevocably agree not to seek forgiveness, the IRS says you may deduct those expenses under an applicable safe-harbor provision.
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