Treasury guidance disallows deductions related to PPP loan proceeds if forgiveness expected

The Department of Treasury and the IRS released Revenue Ruling 2020-27, providing that taxpayers who received Paycheck Protection Program (PPP) loans cannot deduct expenses funded by the debt if forgiveness is reasonably expected. In other words, if the taxpayer has otherwise met the requisite conditions for loan forgiveness, associated expenses are nondeductible if forgiveness has not yet been approved by the lender or even applied for by the end of the borrower’s taxable year.

This addresses an issue outstanding since the IRS released Notice 2020-32 in April, which originally provided that expenses funded by forgiven loan proceeds are nondeductible (see our previous tax alert). As the Coronavirus Aid, Relief, and Economic Security (CARES) Act excludes PPP loan forgiveness from gross income, the IRS’ position under the notice was based on a general tax principle that disallows deductions for expenses incurred in the production of tax-exempt income. Given that borrowers have as long as 24 weeks to use the loan for eligible expenditures and Small Business Administration (SBA) rules give lenders and the SBA up to a combined five months to process forgiveness applications, the notice left unanswered the question of how expenses should be treated in the likely event that a loan was still outstanding at the end of the tax year in which the costs were incurred. See our 2020 year-end tax letter article on this topic for additional discussion.

Revenue Ruling 2020-27 reiterates the position taken under the notice and applies it two separate fact patterns:

1. A borrower with a calendar tax year incurs expenses that are eligible for forgiveness under the CARES Act and SBA guidance and applies for loan forgiveness in November 2020. The borrower otherwise meets all conditions for full forgiveness of the loan, but has not received a decision prior to year-end.
2. The same facts as above apply, except the borrower has not applied for forgiveness as of year-end, rather, they expect to apply in 2021.

In both instances, the taxpayer’s expenses are nondeductible.

In addition to the revenue ruling, the Treasury and IRS concurrently released Revenue Procedure 2020-51, allowing taxpayers to deduct such expenses if forgiveness is fully or partially denied or if the borrower voluntarily withdraws its forgiveness application.