Earlier this year the IRS issued Notice 2020-32 declaring their position that expenses paid with forgiven PPP funds would not be deductible for federal tax purposes. The Franchise Tax Board (FTB) has taken the same position for California tax purposes. While this was unwelcome news for taxpayers (and may have been contrary to lawmakers’ intentions), it left some open questions with regards to timing. Recent IRS guidance resolves these questions and provides a deduction safe harbor for certain businesses. This Tax Alert explains the guidance contained in Revenue Ruling 2020-27 and Revenue Procedure 2020-51 and their impact on the 2020 tax considerations for certain businesses.
Revenue Ruling 2020-27
Taxpayers who received PPP loans and were expecting full or partial forgiveness have raised questions about the timing of the non-deductibility of their expenses. Specifically, if the business waited until 2021 to apply for forgiveness (or applied at the end of 2020 but had not received official forgiveness notification from their lender by Dec. 31, 2020), could they deduct their PPP-funded expenses on their 2020 tax returns? If so, would they then need to amend those returns, report income or reduce expenses in 2021 when forgiveness was granted?
The IRS guidance in Revenue Ruling 2020-27 answers these questions, holding that if a taxpayer has a reasonable expectation of PPP loan forgiveness at the end of their tax year, then they may not deduct the PPP-funded expenses in their 2020 tax return. Delaying the forgiveness application until 2021 does not change this treatment.
GHJ Observation: If a taxpayer has met the forgiveness requirements for the PPP loan program at the end of its tax year, then it is reasonably expected to receive forgiveness of the loan. Even if it has not applied for, or yet received, forgiveness until the next tax year, the expenses are not deductible in the year they were paid or incurred. This effect should be considered in 2020 Q4 estimate, extension, and partnership tax distribution calculations, as applicable. It should also be considered in tax provision calculations for 2020 GAAP financial statements.
GHJ Observation: GHJ expects the FTB to conform to the federal guidance regarding the deductibility of expenses for California tax purposes. Currently, the final AB 1577 analysis states that if the expenses are deducted in 2020 and the loan is forgiven in 2021, then generally the taxpayer has to amend their 2020 filing. The intent of the law is to disallow the expenses to the extent they are paid with funds from forgiven PPP loans.
Revenue Procedure 2020-51
For taxpayers that have their forgiveness request denied, in whole or in part, or who decide not to even apply for forgiveness, Revenue Procedure 2020-51 creates a safe harbor that allows for PPP-funded expense deduction in tax year 2020, even if there was a reasonable expectation of forgiveness at year-end. A taxpayer meeting the requirements of this Revenue Procedure may be able to deduct some or all of the applicable expenses on either their:
- Original 2020 return
- Amended 2020 return, or
- Original return for the next tax year (2021)
A statement must be attached to the taxpayer’s return disclosing, among other things, the amount of deducted and non-deducted PPP-funded expenses reported on their return.
GHJ Observation: Taxpayers who qualify for this safe harbor should evaluate the impact of deducting the expenses on their 2020 returns vs the subsequent year’s return. Various factors including, but not limited to, changes in ownership, section 163(j) interest limitations, or the section 199A deduction should be considered.
It should be noted that many organizations, including the AICPA, continue to push the federal government to ultimately allow the deduction of PPP-funded expenses. Taxpayers may consider extending their 2020 tax returns in case further legislation is passed to allow for deductibility of the expenses.
GHJ will continue to monitor this matter and to provide updates as needed. Please contact a GHJ tax advisor with any questions or to discuss how above may affect you or your business.