PPP Loan Expenses May Not Be Deductible
November 19, 2020
This timely tax update is applicable to any business owner who applied for a Paycheck Protection Program (PPP) loan and is hoping to deduct qualified expenses from their 2020 taxable income.
Yesterday, November 18th, the IRS released Revenue Ruling 2020-27 to provide clarification on PPP loan forgiveness and the deductibility of expenses incurred with PPP proceeds. The PPP was enacted in March and provides loans that can be forgiven on a tax-free basis if portions of the proceeds are spent on certain qualified costs, including payroll, rent, utilities, and interest.
According to the ruling, borrowers who reasonably expect their PPP loans to be forgiven may not deduct expenses incurred with loan proceeds for that tax year — even if the borrower hasn’t even applied for forgiveness yet.
This ruling negates the possibility that borrowers could still deduct expenses incurred with PPP funds for tax year 2020 if they apply for loan forgiveness in 2021. It now appears as though the only way a borrower can deduct expenses incurred with PPP proceeds are if their loan forgiveness application is partially or fully denied, if they have reasonable expectations that forgiveness will be denied, if they withdraw their loan forgiveness application, or if they never apply for forgiveness in the first place. This is regardless of the timing of loan issuance and loan forgiveness.
There does exist a safe harbor, Revenue Procedure 2020-51, for borrowers who initially expect their loans to be forgiven in a taxable year after the 2020 taxable year, but who later learn that forgiveness is partially or fully denied, or for borrowers who never apply for forgiveness in the first place. Under this safe harbor, those borrowers may, in future years, deduct PPP expenses (provided those expenses weren’t deducted in the prior year) up to the amount of their PPP loan principal balance.
Below are some example situations to help put this in perspective:
- Borrower A applied for and received a PPP loan in 2020. She immediately used her loan proceeds for qualified expenses like payroll and mortgage payments. She applied for forgiveness in September and, in October, was informed that her forgiveness application was accepted. Borrower A may not deduct any of her PPP expenses in 2020.
- Borrower B applied for and received a PPP loan in 2020. He immediately used his loan proceeds for qualified expenses like utility payments. He applied for forgiveness in November and hasn’t heard back yet, though he is optimistic that he’ll receive full forgiveness. Borrower B may not deduct any of his PPP expenses in 2020. But per the safe harbor, if Borrower B finds out in 2021 that his loan forgiveness application was fully rejected, he may deduct PPP expenses in tax year 2021.
- Borrower C applied for and received a PPP loan in 2020. They immediately used PPP loan proceeds for qualified expenses like rent and interest. Borrower C does not reasonably believe that their PPP loan will be forgiven, and doesn’t apply for loan forgiveness. Borrower C may deduct PPP expenses from their 2020 taxable income.
The recently releases from the IRS may be of particular interest to borrowers with PPP loans of $2 million and more because they are not eligible for the SBA’s economic necessity safe-harbor. In these situations the borrowers may have spent the loan proceeds in accordance with the rules of the Program but be denied forgiveness based on a decision of the SBA regarding the borrower’s economic necessity.
For its part, Congress has indicated that it intended the expenses paid with PPP loans to be tax deductible. We may see support for narrow legislation in 2021 to provide such tax relief.
If you have any questions whatsoever about this new ruling or PPP loans in general, please don’t hesitate to reach out to your Geffen Mesher professional.