Recently, the IRS released Revenue Ruling 2020-27 addressing the question that many of us have as to whether a taxpayer that received a PPP loan can deduct expenses paid during its 2020 taxable year if at the end of the year the taxpayer reasonably expects to receive forgiveness of its PPP loan. This ruling reaffirms the IRS view that the payment of otherwise deductible expenses allocable to tax exempt income (like PPP loan forgiveness) are not allowed as tax deductions. Whether or not the tax-exempt income has been received or accrued by the end of the business’s 2020 taxable year does not affect the determination of deductibility. This is the case whether or not the business files for forgiveness of the PPP loan before or after the end of its 2020 taxable year.
Along with the revenue ruling referenced to above, the IRS also published much anticipated guidance regarding PPP loans via Revenue Procedure 2020-51. There will be cases where the PPP loan will not be forgiven. In those instances, the business will be able to deduct the related expenses. This procedure provides the taxpayer with a safe harbor means of claiming a deduction for expenses paid with PPP loan proceeds if, in a subsequent year, the taxpayer’s request for forgiveness of the loan is denied in its entirety or partially, or if the taxpayer chooses not to file for forgiveness. The IRS strongly recommends that businesses submit their applications for loan forgiveness as soon as possible.
The loss of these deductions which includes payroll, rent and other expenses will increase the taxpayer’s 2020 federal and possibly state tax liabilities and should be considered closely during year-end tax planning. Also, a taxpayer must review the effects of the loan forgiveness on other areas of federal tax law such as the Section 199A Qualified Business Income (QBI) deduction and the Research & Development (R&D) Tax Credit.
Many taxpayers have utilized their PPP loans to pay for otherwise deductible expenses and wages which are integral in calculating the QBI deduction and R&D credits. If the taxpayer uses PPP loan funds to pay for expenses generally eligible for the R&D credit, those expenses could be disqualified when calculating the total amount of qualified research expenses. This in turn could reduce the amount of the credit claimed. We recommend that taxpayers closely examine the allocation of their PPP loan expenses. Future IRS pronouncements are likely to address and elaborate upon the allocation of expenses paid for with PPP loan proceeds. Congress is also likely to review bills relating to the deductibility of these expenses.