In response to COVID-19, the Coronavirus Aid, Relief and Economic Security (CARES) Act was enacted whereby Paycheck Protection Program (PPP) e-loans made from February 15, 2020 to August 8, 2020 may be forgiven. The cancelled debt will be excluded from income under Reg. 1.265.1. Taxpayers cannot deduct expenses that are allocable to income, whether they are excluded from income or exempt from taxes. The IRS has previously determined that businesses whose PPP loans are forgiven cannot deduct business expenses paid for by the loan.

In Rev. Ruling 2020-27, the IRS amplifies guidance in Notice 2020-32 that businesses whose PPP loans are forgiven cannot deduct business expenses paid for by the loan. A taxpayer who received a PPP loan and paid or incurred certain deductible expenses may not deduct those expenses in the tax year in which those expenses were paid or incurred if, at the end of the year, the taxpayer reasonably expects to receive forgiveness of the covered loan.

In Rev. Proc. 2020-51, dated November20, 2020, the IRS provides a safe harbor allowing taxpayers to claim a deduction in the tax year beginning or ending in 2020 for deductible eligible expenses.

The provisions of Rev. Proc. 2020-51 are as follows:

• The eligible expenses are paid or incurred during the taxpayer’s 2020 tax year,
• The taxpayer receives a PPP loan that at the end of the taxpayer’s 2020 tax year, the taxpayer expects the loan to be forgiven in a subsequent year, and
• In a subsequent year the taxpayer’s request for forgiveness of the loan is denied in whole or in part or the taxpayer decides not to request forgiveness of the loan

Tax Year

A taxpayer may be able to deduct part or all of the eligible expenses on:

• The taxpayer’s timely including extensions of originally filed income tax return or information return for 2020,
• An amended tax return or an administrative adjustment request under IRC 6227 for the 2020 tax year, or
• The taxpayer’s timely including extensions of originally filed tax income tax return or information return for the subsequent tax year.

To apply for the safe harbor, a taxpayer must attach a statement to the return on which the taxpayer deducts the expenses. The statement must be titled Revenue Procedure 2020-51 Statement and must include the following:

• The taxpayer’s name, address, and Social Security number or employer identification number,
• A statement that the taxpayer is an eligible taxpayer under Section 3.01 or Section 3.02 of Revenue Procedure 2020.51,
• A statement that the taxpayer is applying the safe harbor procedures under Section4.01 or Section 4.02 of Revenue Procedure 2020-51,
• The amount and date of disbursement of the taxpayer’s PPP loan,
• The total amount of covered loan forgiveness that the taxpayer was denied or decided to no longer seek,
• The date the taxpayer was denied or decided to no longer seek covered loan forgiveness,
• The total amount of eligible expenses and nondeductible eligible expenses that are reported on the return.

To illustrate the principles of the PPP loan, assume that ABC Company, a C corporation, has a PPP loan in the amount of $200,000. The operations for the year ended December 31, 2020 are as follows:

Sales                                                                           $ 1,500,000

Expenses                             $ 1,250,000

Less: PPP Loan                       200,000

Net  Expenses                                                            1,050,000 

Net Income                                                                  450,000

Corporate Tax Rate                                                            21%     

Tax                                                                                   $ 94,500

Under Rev. Proc. 2020-27, the IRS holds that even if the PPP loan is forgiven or forgiveness has not been applied before year-end taxpayers cannot deduct expenses paid with PPP funds if they expect the loan to be forgiven.

Rev. Proc. 2020-51 provides a safe harbor for taxpayers whose PPP loan forgiveness has been partially or fully denied or decides not to seek forgiveness and wish to claim deductions for eligible payment of expenses. In the above example, if management decided not to apply for forgiveness, or forgiveness was denied, the tax would be $52,500 for a saving of $42,000.

As an alternative, if the taxpayer is not applying for forgiveness, or forgiveness is denied, and the resulting affect is a loss, this could be carried back five years where corporate tax rates were higher or an election made to carry the loss forward.

On Monday, December 21, 2020, both houses of Congress voted to pass the latest COVID-19 relief package which, with all indications, will be signed by the president.

Amongst the provisions of the second stimulus package is that business expenses paid with the proceeds of the PPP loan are deductible. In addition, the law provides that the process for loan forgiveness has been simplified with PPP loans of $150,000 or less.

In conclusion, accountants should prepare tax projections with and without loan forgiveness, and discuss the results with their clients so that an intelligent decision can be made.