If Seeking PPP Loan Forgiveness, Eligible PPP Expenses Are Not Deductible

As year-end tax reporting season approaches, many business owners who obtained relief under the Paycheck Protection Program (PPP) this year need to understand the rules for deducting expenses paid with PPP funds if they plan to seek loan forgiveness either this year or in the future.

Back in May, the IRS issued Notice 2020-32 which stated “no deduction would be allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of the covered loan.” This triggered confusion among PPP borrowers, so in November, the IRS issued Revenue Ruling 2020-27 which indicates that because businesses aren’t taxed on the proceeds of a forgiven PPP loan, PPP expenses are not deductible if used to obtain PPP loan forgiveness.

The guidance was issued for calendar-year filing, but it does not address fiscal-year filing. It also does not address how to allocate nondeductible expenses among the various expenses used for the loan forgiveness application.

Calendar-Year Filing

Expenses are nondeductible for year-end 2020 if there is a reasonable expectation of loan forgiveness, regardless of whether the borrower files a forgiveness application in 2020 or 2021 and when the actual forgiveness event occurs.

The basis for this ruling is that a PPP borrower has a reasonable expectation of reimbursement (as reimbursement is not unforeseeable) and, therefore, a deduction in 2020 is disallowed. The ruling follows the line of authorities addressing reimbursements, which holds that otherwise allowable deductions are disallowed if there is a reasonable expectation of reimbursement.

The actual filing of the forgiveness application and the ultimate forgiveness decision are not material to the analysis. In fact, the ruling specifically indicates that it does not matter if a borrower has applied for forgiveness or not. Only the amount of the loan that is forgiven results in nondeductible expenses so if a borrower only obtains partial loan forgiveness, only the expenses used for the part ultimately forgiven are nondeductible.

Fiscal-Year Filing

Although the ruling addresses calendar-year filing, fiscal-year filers can infer guidance for their situations. The ruling indicates that the borrower has a reasonable expectation of the loan being forgiven, so it follows that a fiscal-year taxpayer would look to when the expenses were incurred or paid to qualify for forgiveness. The two factors to consider are the date the PPP loan was received and the fiscal year-end of the taxpayer. Two examples illustrate how expenses could be handled:

• In example A, a borrower has an October fiscal year-end and the loan proceeds were received in June. It is likely that the expenses used for loan forgiveness would spread through December and thus span multiple tax years– fiscal year 2020 and fiscal year 2021. Although the IRS did not issue specific guidance for this situation, it seems reasonable that an allocation of the expenses between the two tax years would be acceptable.
• In example B, a borrower with an October 31 fiscal year-end applied for and received a PPP loan with an April loan date. It is likely that most, if not all, of the expenses were incurred between April and October 2020. Therefore, taxpayers should consider these expenses as nondeductible for the October 2020 fiscal year-end tax return.

More Guidance Needed

Although several members of Congress disagree with the conclusion that costs are nondeductible, the U.S. Treasury (to date) has not changed its decision. As a result, there are still many unknowns regarding the allocation of expenses used for loan forgiveness. For many taxpayers, it may not matter whether wages, employee benefits, rent, utilities or interest are reduced. However, for those taxpayers with a research and development tax credit or who qualify for a qualified business income (QBI) deduction, the allocation to wages definitely will matter.

It is helpful to keep in mind that the PPP has provided much needed relief to many businesses during the pandemic. However, the PPP has been a journey with many twists and turns, and more are likely to follow. Business owners should remain patient and act cautiously by not making an irreversible decision until absolutely necessary. ALL CPAs can help you plan for various possibilities as we all patiently await further guidance.

If you have any questions about this please contact your ALL tax advisor or call us at 617-738-5200.