To help stimulate the economy and provide financial assistance to individuals and businesses, the CARES Act (“Act”) was signed into law and the Paycheck Protection Program (“PPP”) Loan was introduced. Qualifying businesses were able to apply for a low-interest loan with the promise that most of the loan proceeds could be forgiven, if spent on eligible expenses, and they would not be taxed on that forgiven debt. Generally, cancellation of debt is considered taxable income. The language included in the Act expressed Congress’ intent to help small businesses not face additional financial burdens by paying taxes on the forgiven PPP Loans. The Internal Revenue Service (“IRS”) was quick in challenging Congress’ intentions by introducing a notice that stated the expenses associated with forgiven PPP loans were not deductible.
When the IRS introduced Notice 2020-32, it came with much criticism. Party members from both sides spoke out stating that the stance taken by the IRS was against the intentions of the Act. Backed by Section 265(a) of the IRS code, the notice indicated that expenses associated with nontaxable income were nondeductible. Additionally, if there was a reasonable expectation of loan forgiveness, the expenses associated were nondeductible. The IRS is not saying the forgiven loan is taxable, but their stance is essentially making the loan forgiveness a taxable event. Ever since the notice came out in May of 2020, taxpayers and practitioners have looked for additional guidance from the IRS and speculated on the timing of when to exclude the expenses from taxable income. Due to the timing and procedures of the forgiveness process, many taxpayers would not receive final approval until 2021. With the proceeds still considered a loan on a company’s financial statements at the end of 2020, one could argue the expenses are deductible in 2020. However, under relevant law, many believed that the IRS would take the stance that the expenses would be nondeductible in the year they were expensed. Many were planning both scenarios hoping that Congress would step in our additional guidance was released. The IRS provided additional guidance on November 18th by doubling down on their stance indicating the timing on when to exclude the expenses.
Revenue Ruling 2020-27 strengthened the IRS’ stance on the deductibility of the expenses while providing insight on when to exclude them. The ruling indicates that if a loan is reasonably expected to be forgiven in a year after 2020, a taxpayer is not allowed to deduct the expenses on their 2020 return. Based on the loan forgiveness qualifications and procedures currently in place, the IRS is stating that all loan recipients have the ability to reasonably determine if they qualify for forgiveness. If a recipient expects they will not qualify for 100% forgiveness or decides to not seek forgiveness, the IRS is allowing them to deduct some or all of the associated expenses by following Revenue Procedure 2020-51. The procedure is a safe harbor allowing qualifying taxpayers to deduct their expenses on a 2020 tax return. To qualify, a taxpayer must expect all or some for their loan to not be forgiveness or decide to not seek forgiveness in a subsequent year. Again, members of Congress have expressed their dissatisfaction with the IRS stance on the issue. In order to change the IRS’s interpretation of the law, an act of congress will need to be made to clearly state the expenses related to loan forgiveness are deductible.
Certain bills have been introduced to clear the issue but there has been no action taken to do so. Until a new law is put into place, taxpayers will need to start planning on how the impact of the PPP loan will affect their 2020 taxes, both business and personal. If you have additional questions or would like to request more information, please contact Neil Zinser, Tax Partner, or your Strothman and Company representative.