The Paycheck Protection Program (“PPP”), passed as part of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), was a welcome relief for small businesses, providing a financial lifeline through the recession caused by COVID-19. The fact that forgiven loans wouldn’t be taxable income made PPP even more useful. There was, however, the question of whether expenses paid with forgiven PPP loans would be deductible. The law did not address this deductibility question despite various members of the House and Senate saying that their intention was to allow it.
Into the void sprung the Internal Revenue Service (“IRS”). In April, the IRS released a notice saying they would not allow a deduction for expenses paid with the proceeds of a forgiven PPP loan. But, IRS Notices are just an indication of what the Service intends to provide as guidance in the future. As a result, borrowers and practitioners were still uncertain as to the status of these expenses for tax purposes. And, around the same time, several bills were introduced in the House and Senate to make the Congressional intent regarding deductibility into law. But none were acted on.
The Revenue Ruling explicitly states that if a taxpayer received a PPP loan and paid or incurred otherwise deductible expenses, those expenses are not deductible if the taxpayer reasonably expects to receive forgiveness of the loan. That applies whether or not they have applied for forgiveness by the end of the taxable year.
The Revenue Procedure provides a safe harbor for taxpayers who do not deduct expenses in anticipation of the loan being forgiven and whose forgiveness is later denied in whole or in part or who later decide not to request forgiveness.
Observation: Neither IRS release offers any guidance with respect to the effect on other tax provisions that are measured by or with reference to taxable income or deductions. These include, among others, the business interest expense limitation, qualified business income deduction, and the research and development credit.
What does this mean for you? It is still possible that Congress will pass legislation making the expenses deductible. It is highly unlikely that will happen in the lame duck session that is about to begin but is possible by the end of January in the new Congress. On the other hand, the IRS release may spur action in Congress. Sen. John Cornyn’s bill has significant bi-partisan support and advocacy by the AICPA, among other organizations.
With that in mind, we continue to generally recommend you wait to file a forgiveness application. You should, however, review your particular circumstances with your advisors to determine the best course of action. Most borrowers still are well within the forgiveness application window – 10 months from the end of the covered period of the loan. If Congress hasn’t acted by the tax filing deadlines in March and April, we will likely recommend requesting an extension of time to file returns in the hope that the proposed legislation will pass before the extended due date.
Expect to hear more about this issue over the coming weeks. In the meantime, please contact your Friedman LLP advisor