IRS rules: Deductions not permitted if there is a reasonable expectation of PPP loan forgiveness

The IRS issued guidance Nov. 18 reiterating its position that taxpayers cannot deduct expenses funded with proceeds from a Paycheck Protection Program (PPP) loan where the taxpayer can reasonably expect the loan to be forgiven. Concurrently, the IRS issued a safe harbor for taxpayers to take deductions in the 2020 taxable year if they anticipate partial or no loan forgiveness in a subsequent year. 

Rev. Rul. 2020-27: Deductions not permitted if taxpayer reasonably expects PPP loan forgiveness

At the end of April, the IRS issued Notice 2020-32 stating that expenses paid for or incurred with PPP loan proceeds are not deductible if the loan is forgiven. However, due to the program structure and timeline, it’s possible that expenses paid for or incurred in one year may not be forgiven until a later year. This created uncertainty as to whether, or when, such expenses would be deductible.

On Nov. 18, the IRS issued Revenue Ruling 2020-27 to clarify that point, stating that taxpayers cannot deduct expenses where the expenses were funded by a PPP loan and the taxpayer can reasonably expect such loan to be forgiven, even if forgiven in a later year. 

Revenue Ruling 2020-27 outlines two example situations. In the first, a taxpayer uses PPP loan proceeds to pay expenses that are eligible for forgiveness under the Coronavirus Aid, Relief, and Economic Security (CARES) Act (qualifying payroll, rent, etc.). The taxpayer satisfies all other requirements for loan forgiveness and applies for loan forgiveness before year-end, but is not informed whether the loan will be forgiven by year-end. 

The second situation is the same as the first, except that the taxpayer does not apply for loan forgiveness in the current year, but plans to do so in a subsequent year. 

Per the Revenue Ruling, taxpayers in both situations may not deduct expenses paid for with their PPP loan proceeds because each taxpayer, based on the facts provided, can reasonably expect the loans to be forgiven. Significantly, it is the IRS’s position that expenses are not deductible, provided the taxpayer can reasonably expect the loan to be forgiven, irrespective of whether the taxpayer has applied for loan forgiveness in the current year. 

Rev. Proc. 2020-51: Safe harbor for 2020 taxable year 

Certain taxpayers that anticipate partial or no forgiveness of their PPP loans can use a safe harbor to take deductions in the 2020 taxable year. 

Revenue Procedure 2020-51 outlines two situations. In the first situation, the taxpayer did not take any deductions for eligible expenses in 2020 because the taxpayer reasonably expected the loan to be forgiven. The taxpayer submitted (or intended to submit by the end of 2020) an application for loan forgiveness, and, in a subsequent year, either all or a portion of the loan was not forgiven. 

The second situation is the same as the first, except that the taxpayer decided not to seek loan forgiveness in the subsequent year for all or a portion of the PPP loan (e.g., the taxpayer did not file, or withdrew their application). 

Safe harbor for 2020: Taxpayers may deduct eligible expenses on their originally filed 2020 return or on an amended return or AAR (administrative adjustment request), as applicable. This safe harbor would generally be claimed on an original return if the taxpayer learns of the denial (or decides to withdraw) after their year-end but before their return was filed. A return would need to be amended if a taxpayer was denied in the subsequent year (or decided to withdraw) after their 2020 return was filed and they chose not to use the subsequent-year safe harbor.

Safe harbor for subsequent year: Taxpayers may deduct eligible expenses on their originally filed income tax return for the subsequent year, as applicable. This would apply to a taxpayer that filed their 2020 return, and then in the subsequent year the request was denied (or they decided to withdraw), but rather than amend the 2020 return, they opt to take the deduction in that subsequent year.

Note that a statement must be included when filing for the safe harbor; see the full revenue procedure for details. 

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