The IRS has confirmed its guidance that 2020 business expenses paid for with Paycheck Protection Program (PPP) loan proceeds are not deductible for the 2020 tax year. For business owners who received PPP loans, this means preparation for tax season will require careful attention to which business expenses may be deductible and which may not.

On November 19, 2020, the IRS released two updates to the PPP, Revenue Ruling 2020-27 and Revenue Procedure 2020-51. As background, the Payroll Protection Program was created by the Coronavirus Aid, Relief and Economic Security (CARES) Act, enacted in March 2020 to help business owners adversely affected by the Covid-19 emergency pay payroll and other operating expenses.  

Specifically, business owners could apply for funding from their normal lenders to help pay payroll costs, interest expense, rent and utility payments. If the loan proceeds were used for these purposes during the period of the loan, the loan would be forgiven and would not constitute taxable income.

In May 2020, the Internal Revenue Service issued guidance stating that expenses paid with the PPP funds would be non-deductible for tax purposes, even though they were normally deductible business expenses.

As the guidance issued in May left a lot of unanswered questions, the November guidance was intended to clarify the IRS’s position.

The clarified guidance provides that a taxpayer may not deduct for 2020 otherwise deductible expenses, if:

• The taxpayer “reasonably expects,” based on the expenses paid during 2020, that the loan will be forgiven, and
• The taxpayer has applied to their lender for forgiveness of the loan, or
• The taxpayer has not heard back from the lender if the loan will be forgiven, or
• The taxpayer has not filed with its lender for forgiveness of its loan by the end of 2020.

Further the IRS provided taxpayers a safe harbor in Revenue Procedure 2020-51 for deducting otherwise non-deductible expenses in 2020 or in a subsequent year for a taxpayer who reasonably expected that a loan would be forgiven but whose loan forgiveness application was later denied or partially denied.  

To utilize the safe harbor:

• The taxpayer needs to have paid or incurred the qualified expenses in the 2020 tax year.
• The taxpayer also needs to have submitted by the end of 2020, or must intend to submit in a subsequent year, an application for loan forgiveness.
• The safe harbor also is available if, in a subsequent tax year, the taxpayer’s application for forgiveness is denied; or the taxpayer decides not to seek forgiveness for some or all the loan.

If you have questions about how to account for your business’s use of PPP loan proceeds as we head into tax season, please contact your G.T. Reilly advisor.