On November 18, the IRS released Revenue Ruling 2020-27, which states that a taxpayer who reasonably expects full PPP loan forgiveness is not allowed to deduct expenses up to the loan forgiveness amount for the year in which the expenses are incurred.
Two situations laid out by the IRS
The IRS laid out two situations for calendar-year taxpayers in the revenue ruling.
In situation one, the taxpayer incurs qualified PPP expenses and applies for loan forgiveness in November 2020. The taxpayer satisfies all the requirements under the CARES Act for loan forgiveness, but they do not receive notice from the lender on loan forgiveness before their year-end.
In situation two, the facts are the same except the taxpayer has not filed their loan forgiveness application before their year-end. The taxpayer intends to file the loan forgiveness application in 2021 and reasonably expects full loan forgiveness.
According to the IRS, in both situations the taxpayer can’t deduct expenses funded with PPP loans in the year incurred because they have a reasonable expectation of forgiveness. The IRS position is that at the end of the tax year, the reimbursement of their eligible expenses, in the form of covered loan forgiveness, is reasonably foreseeable, making it inappropriate to claim the deductions.
What if you don’t have a reasonable expectation of loan forgiveness?
It seems that any time the Treasury issues guidance related to PPP loans, unanswered questions remain.
In the revenue ruling, the IRS does not provide any guidance or examples of when there may be enough uncertainty for there not to be a reasonable expectation of loan forgiveness. For example, if taxpayer has sufficient PPP qualified expenses but may not meet the economic uncertainty safe harbor, is there a reasonable expectation of loan forgiveness? In such an instance, could taking the deductions be used against the taxpayer as an admission that they did not meet the economic uncertainty requirement?
What about allocating nondeductible expenses?
The revenue ruling also does not provide any guidance on how the amount of nondeductible expenses should be allocated to the qualified PPP expenses incurred during the covered period.
If a taxpayer has a $1.0 million PPP loan and, during their covered period, they incurred $1.5 million of qualified PPP expenses in the form of wages, rents and utilities, how should they allocate those expenses to the extent of the tax-exempt PPP loan forgiveness amount? The allocation could impact other tax deductions and credits such as the qualified business income deduction and the research and development tax credit calculations.
What if you’re self-employed?
And yet another question that remains is, how does the IRS reconcile the results in the examples in this revenue ruling with the fact that a self-employed individual without employees that received a PPP loan does not have any related expenses for which the deduction is denied? Should they have a more favorable result than a similarly situated corporation or partnership?
Moving forward with current guidance
Although it is possible that the IRS position will ultimately be over-ridden by subsequent legislation or in the courts, the revenue ruling is the current IRS position, and taxpayers will need to determine how their facts align with the situations in the revenue ruling.
If you have any questions about Revenue Ruling 2020-27 or your specific situation with regard to PPP loan forgiveness and expenses, contact Wipfli.