The IRS has not been kind to Payroll Protection Program (PPP) loans. Earlier this year the IRS released Notice 2020-32 that denied tax deductions for PPP related expenses which normally would be deductible. Recently with the issuance of IRS Revenue Ruling 2020-27 they addressed two situations where a loan is not yet forgiven but might be in the future. In this ruling, the IRS described two situations.
In the first case, a borrower pays payroll and mortgage interest that are valid PPP expenditures. The borrower applies for forgiveness in November 2020 and satisfied all the requirements under the CARES Act to have it forgiven, but it does not yet have an answer as to whether it will be forgiven.
In the second case, the borrower pays the same type of expenses as in the first situation with the PPP loan, but expects to apply for forgiveness in 2021.
Per Revenue Ruling 2020-27, the IRS says the business cannot deduct these expenses, because the businesses both have a “reasonable expectation” that the loans will be forgiven. The IRS also released Rev. Proc. 2020-51, which provides a safe harbor for PPP borrowers whose loan forgiveness has been partially or fully denied and who wish to claim deductions for otherwise eligible payments on a return, amended return, or administrative adjustment request.
The basis of the IRS’ disallowance of deductions paid for with PPP loans is based in traditional tax principles. These principles deal with receiving tax-exempt income while also claiming deductions related to that tax-exempt income. If the rules are applied consistently, the IRS believes a taxpayer should not be able to get free money, not pay tax on discharge of debt income, and still deduct the expenses associated with that income.
We are actively monitoring the developments of how to apply these rules and will update accordingly.