The Internal Revenue Service and the Treasury Department have issued guidance to clear up the tax treatment of expenses when a loan from the Small Business Administration’s Paycheck Protection Program (PPP) hasn’t been forgiven by the end of the year. (They also released a new, lengthy questionnaire from the SBA for forgiveness of loans of $2 million or more.)

The IRS and the Treasury issued both a revenue ruling and a revenue procedure, essentially saying that since businesses aren’t taxed on the proceeds of a forgiven PPP loan, the expenses aren’t deductible.

"This results in neither a tax benefit nor tax harm since the taxpayer has not paid anything out of pocket," said the Treasury in a news release. "If a business reasonably believes that a PPP loan will be forgiven in the future, expenses related to the loan are not deductible, whether the business has filed for forgiveness or not. Therefore, we encourage businesses to file for forgiveness as soon as possible."

In cases where a PPP loan was expected to be forgiven, but it isn’t, businesses will be able to deduct those expenses. “Today’s guidance provides taxpayers with greater clarity and flexibility,” said Treasury Secretary Steven Mnuchin in a statement Wednesday. “These provisions ensure that all small businesses receiving PPP loans are treated fairly, and we continue to encourage borrowers to file for loan forgiveness as quickly as possible.”

The revenue procedure issued by the IRS and the Treasury, Rev. Proc. 2020-51, provides a safe harbor for PPP loan participants whose loan forgiveness has been partially or fully denied, or who decide to forego requesting loan forgiveness, to claim a deduction for certain otherwise deductible eligible payments on (1) the taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for the 2020 taxable year, or (2) an amended return or an administrative adjustment request (AAR) under section 6227 of the Tax Code for the 2020 taxable year, as applicable. For taxpayers who decide to forego requesting loan forgiveness, the safe harbor also permits these taxpayers to claim a deduction for the otherwise deductible eligible payments on an original income tax return or information return, as applicable, for the taxable year in which the taxpayer decides to forego requesting forgiveness.

The revenue ruling, Rev. Rul. 2020-27, offers guidance on whether a PPP loan participant that has paid or incurred certain otherwise deductible expenses can deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan. The revenue ruling also includes guidance if, as of the end of the 2020 tax year, the PPP loan participant has not applied for forgiveness, but intends to apply in the next taxable year.

Both pieces of guidance answer some questions, but some tax experts will still have questions. “While the Ruling and Rev Proc provide information on the deductibility of expenses and the tactical approach for borrowers whose forgiveness is denied or not requested, additional clarification is still needed,” said an email to clients Thursday from Aprio, a Top 100 Firm. “This guidance does not address the order in which the eligible expenses (payroll, rent, utilities and mortgage interest) lose the ability to be deducted. Further, the guidance does not address other matters that could have significant tax implications including, but not limited to, the impact on the following:

• Qualified business income deduction (Section 199A);
• Research and development credits; and
• Interest deduction limitation (Section 163(j)).

The IRS and the Treasury also recently released guidance in Notice 2020-32 about deducting expenses for PPP loans. The notice clarifies that no deduction is allowed under the Tax Code for an expense that is otherwise deductible if the payment of the expense results in forgiveness of the loan under the CARES Act, and the income associated with the forgiveness is excluded from gross income.

The leaders of the Senate Finance Committee, chairman Chuck Grassley (R-Iowa), who is now battling a coronavirus infection, and ranking member Ron Wyden (D-Oregon) blasted the guidance issued by the Treasury. “Since the CARES Act, we’ve stressed that our intent was for small businesses receiving Paycheck Protection Program loans to receive the benefit of their deductions for ordinary and necessary business expenses,” they said in a joint statement Thursday. “We explicitly included language in the CARES Act to ensure that PPP loan recipients whose loans are forgiven are not required to treat the loan proceeds as taxable income. As we’ve stated previously, Treasury’s approach in Notice 2020-32 effectively renders that provision meaningless. Regrettably, Treasury has now doubled down on its position in new guidance that increases the tax burden on small businesses by accelerating their tax liability, all at a time when many businesses continue to struggle and some are again beginning to close. Small businesses need help maintaining their cash flow, not more strains on it.”

Grassley and Wyden said they would continue their efforts to clarify in any end-of-year legislation the intended relief in the CARES Act to help small businesses at this critical time. “We encourage Treasury to reconsider its position on the deductibility of these expenses, and the timing of those deductions, to provide relief to the small businesses that need it most,” they added.