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After months of speculation, the Treasury Department and IRS have addressed the concerns that borrowers have regarding the deductibility of expenditures funded by their Paycheck Protection Program loans for federal income tax purposes.
On November 18, 2020, the IRS issued Revenue Ruling 2020-27, which provides guidance on whether a Paycheck Protection Program (PPP) loan participant who paid or incurred deductible expenses can deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan.
The IRS provided two scenarios in the revenue ruling. In the first scenario, the borrower pays expenses including payroll and mortgage interest that qualify under the CARES Act as valid PPP expenditures. In this scenario, the borrower applies for forgiveness in November 2020 and satisfied all the requirements under the CARES Act to have their PPP loan forgiven. The borrower doesn’t yet have an answer as to whether the loan will be forgiven.
In the second scenario, the borrower paid the same type of valid expenses with their PPP loan and satisfied the CARES Act requirements for the loan. The borrower does not expect to apply for forgiveness until 2021.
According to the revenue ruling, the businesses in both scenarios can’t deduct expenses funded with their PPP loans because they have a reasonable expectation of forgiveness.
But what if you're a borrower who applied for loan forgiveness and have been partially or fully denied? Or what if you do not apply for forgiveness within the prescribed period? The IRS has also released Revenue Procedure 2020-51, which provides a safe harbor for PPP borrowers in these situations who wish to claim deductions. The safe harbor allows a taxpayer to claim a deduction in the taxpayer's 2020 taxable year for deductible eligible expenses if the request for forgiveness is denied or the taxpayer never requests forgiveness.
If you have any PPP loan questions, don’t hesitate to reach out to your Delap advisor.