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Two New Safe Harbors for Unforgiven PPP Loans

12/4/20 – Dan Kraft

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The IRS recently issued guidance that provides a safe harbor allowing certain taxpayers to claim a deduction in 2020 for some otherwise nondeductible eligible expenses if the taxpayers received Paycheck Protection Program (PPP) loans. (Revenue Procedure 2020-51) This guidance applies if a taxpayer received a PPP loan that:

  • At the end of the taxpayer's 2020 tax year the taxpayer expects to be forgiven in a tax year after the 2020 tax year, and
  • In a post-2020 tax year, the taxpayer's request for forgiveness of the loan is denied, in whole or in part, or the taxpayer decides never to request forgiveness of the loan.

The IRS has also firmly held its ground that the proceeds from the PPP loan that were used for the eligible expenses mentioned later are nondeductible under §265. §265 states that no deduction shall be allowed for any amount otherwise allowable as a deduction which is allocated to one or more classes of income other than interest wholly exempt from tax. Revenue Ruling 2020-27 states that expenses paid in 2020 with the PPP loan proceeds will be nondeductible in 2020 regardless if the loan is forgiven in 2020 or 2021 if the borrower can “reasonably expect” the loan will be forgiven.

Basics about PPP Loans

The Coronavirus Aid, Relief and Economic Security Act (CARES Act) established the PPP as a loan program administered by the U.S. Small Business Administration (SBA) that was designed to assist businesses adversely impacted by the COVID-19 pandemic to pay payroll costs and other eligible expenses.

Under the program, the SBA is allowed to guarantee the full principal amount of a covered loan as a loan made under the PPP during the covered period. A covered loan may be forgiven.

The covered period is the period beginning on February 15, 2020, and ending on December 31, 2020.

An individual or entity that is eligible to receive a covered loan can receive forgiveness of the full principal amount of that loan up to an amount equal to the following costs incurred and payments made during the covered period:

  • Payroll costs,
  • Interest on a covered mortgage obligation,
  • Any covered rent obligation payment and
  • Any covered utility payment.

Under the law, any amount which would be includible in gross income of the eligible recipient by reason of forgiveness shall be excluded from gross income. The law excludes the amount from gross income regardless of whether the amount would be income from the discharge of indebtedness or otherwise includible in gross income under the tax code.

Meanwhile, the tax code provides that, in computing taxable income, certain deductions are allowed.

In IRS guidance issued earlier this year (Revenue Ruling 2020-27), a taxpayer computing taxable income on the basis of a calendar tax year may not deduct eligible expenses in its 2020 tax year under  certain conditions. That is, it cannot deduct those expenses if, at the end of the 2020 tax year, the taxpayer has reason to expect the expenses will be reimbursed (through covered loan forgiveness) based on the eligible expenses paid or accrued during the covered period.

The New Safe Harbor Rules

Revenue Procedure 2020-51 provides two safe harbors to claim deductions for eligible expenses in the 2020 tax year for which no deduction would otherwise be permitted because at the end of the 2020 tax year the taxpayer has reason to expect to receive forgiveness of the covered loan based on those non-deducted eligible expenses.

Safe harbor for deductions to be claimed in 2020 tax year. An eligible taxpayer who satisfies the safe harbor requirements (described below) may deduct non-deducted eligible expenses on the taxpayer's timely filed, (including extensions) original income tax return or information return, as applicable, for the 2020 tax year, or amended return or Administrative Adjustment Request for the 2020 tax year, as applicable.

Safe harbor for deductions to be claimed in subsequent tax year. An eligible taxpayer who satisfies the safe harbor requirements, may deduct non-deducted eligible expenses on the taxpayer's timely filed (including extensions) original income tax return or information return, for a subsequent tax year (that is, a tax year after the 2020 tax year). Eligible taxpayers may choose to use this safe harbor to deduct non-deducted eligible expenses in a subsequent tax year because those taxpayers may deduct the non-deducted eligible expenses in the year that the loan forgiveness is denied under general tax principles — assuming that the taxpayer doesn't elect to the use the safe harbor above.

Safe Harbor Requirements

A taxpayer applying one of the safe harbor procedures may not deduct an amount of non-deducted eligible expenses in excess of the principal amount of the taxpayer's covered loan for which forgiveness was denied or will no longer be sought.

In addition, a taxpayer may not apply the safe harbor procedures to deduct any amount of non-deducted eligible expenses unless the taxpayer attaches a statement to the return on which the taxpayer deducts non-deducted eligible expenses. The statement must be titled "Revenue Procedure 2020-51 Statement." The Revenue Procedure provides details of what must be included in the statement.

Who Is an Eligible Taxpayer?

A taxpayer is eligible to apply either of the safe harbors if the taxpayer meets either of these two requirements.

1. A taxpayer meets the first requirement if:

  • The taxpayer paid or incurred eligible expenses in the 2020 tax year for which no deduction is permitted because at the end of the 2020 tax year the taxpayer reasonably expects to receive forgiveness of the covered loan based on those eligible expenses;
  • The taxpayer submitted before the end of the 2020 tax year (or as of the end of the 2020 tax year intends to submit in a subsequent tax year) an application for covered loan forgiveness to the lender; and
  • In a subsequent tax year, the lender notifies the taxpayer that forgiveness of all or part of the covered loan is denied.

2. A taxpayer meets the second requirement if:

  • The taxpayer meets the requirements in the first two bullets of #1 above and
  • In a subsequent tax year, the taxpayer irrevocably decides not to seek forgiveness for some or all of the covered loan. For example, a taxpayer that determines that it won't qualify for covered loan forgiveness and withdraws the application submitted to the lender.

More Limitations

Nothing in Revenue Procedure 2020-51 precludes the IRS from examining other issues relating to the claimed deductions for non-deducted eligible expenses, including the amount of the deduction and whether the taxpayer has substantiated the deduction claim. The guidance also doesn't preclude the IRS from requesting additional information or documentation verifying any amounts.

Effective date. The Revenue Procedure is effective for tax years beginning or ending in 2020.

Considerations

Revenue Ruling 2020-27 is requiring expenses paid with PPP loan proceeds to be nondeductible in 2020 if there is a reasonable expectation the loan is to be forgiven. One consideration could be to pay the loan proceeds back and not apply or withdraw your loan application. Certain industries may not have been impacted as greatly by the pandemic as others and other industries were able to bounce back quicker than others. If your company has remained or become profitable now that we are almost through quarter 4, you could consider not seeking forgiveness and apply the safe harbor provisions as discussed earlier. Another consideration could be to apply for only partial forgiveness to help manage the amount of nondeductible expense that would ultimately increase your taxable income. Depending on your specific situation and circumstances, the increase in taxable income could result in even more unforeseen tax consequences like increase in tax bracket or rates, subjectivity to other taxes like the net investment income tax, or reduced or loss tax credits.

Questions about PPP Loans?

Many business owners are confused about the details of PPP loans, and our VonLehman tax advisors are happy to clarify any questions you may have. Please contact Dan Kraft or your advisor for more information.