There has been much debate among tax professionals concerning the tax issues surrounding the forgiveness of Paycheck Protection Program (PPP) loans authorized under Section 7(a)(36) of the Small Business Act, which was added by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
A PPP loan may be forgiven based on certain eligible expenses being paid or incurred during the covered period. The covered period is either the eight-week period or 24-week period after the PPP loan is obtained by the taxpayer.
The CARES Act specifically provides that any amount of the forgiven PPP loan shall be excluded from gross income. However, in Notice 2020-32, the Internal Revenue Service (IRS) clarified that no deduction would be allowed for any deductible expense paid with a PPP loan that was forgiven. This of course has the practical effect of making the forgiveness of the PPP loan fully taxable.
The debate among tax professionals revolved around the tax issues raised if a taxpayer did not know at the time a tax return was due if the PPP loan would be forgiven. Specifically, should the taxpayer file the tax return showing the PPP loan as a loan and adjust the tax return in the year actually forgiven under the tax benefit rule, or would the taxpayer file an amended tax return for the year the deductions were taken?
In Revenue Ruling 2020-27, the IRS issued guidance on these issues. Specifically, the revenue ruling provides that if the taxpayer has a reasonable expectation that the PPP loan will be forgiven, the taxpayer cannot deduct the expenses paid with the PPP loan. In the ruling, the IRS specifically rejected the use of the tax benefit doctrine to delay the taxable event until the PPP loan is actually forgiven.
For example, assume the taxpayer obtained a $ 1 million PPP loan, and during the taxpayer’s covered period, used all $1 million to pay payroll expenses. Assume the taxpayer is a calendar-year taxpayer, and the tax return is due March 15, 2021. The taxpayer applies for forgiveness on March 1, 2021. Since the taxpayer only used the PPP loan to pay payroll expenses, the taxpayer reasonably expects the PPP loan will be forgiven. On these facts, even though the PPP loan has not been forgiven, the taxpayer cannot deduct the $1 million in payroll expenses paid in 2020. The result would be identical even if the taxpayer had not applied for forgiveness at the time the tax return was filed so long as the taxpayer had a reasonable expectation at the time the tax return was filed that the PPP loan would be forgiven.
What happens if, despite the taxpayer’s reasonable expectation, the loan is not ultimately forgiven? The IRS issued Revenue Procedure 2020-51 to address this issue. It provides that the taxpayer can file an amended return for the year the taxpayer did not take a deduction for such expenses. In the example above, the taxpayer would have the option of filing an amended return for 2020. Alternatively, the taxpayer can deduct the non-deducted expenses in the year the loan forgiveness is denied or the taxpayer withdraws the application for forgiveness. In either situation, the taxpayer may not deduct an amount of non-deducted eligible expenses in excess of the principal amount of the covered loan for which forgiveness was denied or will no longer be sought.
If you have any questions regarding the content of this alert, please contact Gerry Stack, Tax Practice chair, at gstack@barclaydamon.com, or any other member of the practice area.
We also have a specific team of Barclay Damon attorneys who are actively working on assessing regulatory, legislative, and other governmental updates related to COVID-19 and who are prepared to assist clients. Please contact Yvonne Hennessey, COVID-19 Response Team leader, at yhennessey@barclaydamon.com or any member of the COVID-19 Response Team at COVID-19ResponseTeam@barclaydamon.com.