05 Feb RE: Paycheck Protection Program — Tax Implications of Expenses Paid with a Forgiven PPP Loan
The Internal Revenue Service (IRS) recently issued Revenue Ruling 2020-27 which provides that expenses paid with Paycheck Protection Program (PPP) loan proceeds are not deductible in the tax year paid or incurred, if at the end of the tax year the taxpayer has a “reasonable expectation of forgiveness.” As a result, many calendar-year taxpayers that received a PPP loan will have additional income to report on their 2020 tax return if they wish to be in accord with IRS guidance.
The IRS states in Rev. Rul. 2020-27 that a taxpayer has a reasonable expectation of forgiveness if he/she intends to apply for loan forgiveness. Therefore, unless a taxpayer has decided not to file for loan forgiveness, the taxpayer is presumed to have a reasonable expectation of forgiveness.
Subsequent to the IRS’s ruling, several members of Congress have expressed concern with the IRS’s position and have made it clear that the congressional intent in the CARES Act was to ensure that PPP loan recipients whose loans are forgiven are not required to treat the proceeds as taxable income. Thus, they are strongly encouraging the IRS to reconsider its position on the deductibility of these expenses, and the timing of those deductions, to provide relief to the small businesses that need it most. In addition, there may be state income tax implications as many states have not conformed to the federal government’s tax treatment of PPP loans or related forgiveness.
Although there is a possibility that congressional action could reverse the IRS position, its likelihood remains uncertain. Given the potential of penalties for underpayment of estimated tax because of the disallowance of the related expenses, our firm believes impacted taxpayers should take proactive action. In order to avoid underpayment of estimated tax penalties, taxpayers should increase their withholding or estimated tax payments to satisfy the prior-year tax safe harbor rules (100% / 110% of 2019).
If you have applied, intend to apply, or are undecided as to whether to apply for PPP loan forgiveness, then, absent further guidance, you should consider the following options for the filing of your 2020 federal income tax return:
- Extend your tax return to allow additional time for congressional action in opposition to the IRS position.
- File your tax return based on Notice 2020-32 and Revenue Ruling 2020-27 guidance by NOT deducting expenses paid with forgiven PPP loan proceeds. If the current IRS position is reversed, you can file an amended return to claim these deductions.
- File your tax return taking a deduction for expenses but disclose (i.e., file IRS Form 8275) a position that is contrary to current IRS guidance. Disclosure helps to avoid the imposition of penalties if the IRS ultimately disagrees with the position but likely increases the taxing authority’s scrutiny of your return.
- Choose not to apply for the PPP loan forgiveness and deduct the expenses as usual.
Immediate Action Required
Given the uncertainty that exists with the conflict between the current tax guidance as promulgated by the IRS and the congressional intent of the PPP, we strongly encourage you to reach out to us as soon as possible for some tax planning guidance to help minimize your risk for the potential underpayment of estimated tax penalties because of the disallowance of the related PPP expenses. Again, to avoid underpayment of estimated tax penalties, you may need to increase your estimated tax payments for the 2020 tax year as soon as possible to satisfy the prior-year tax safe harbor rules.
If you have any questions regarding this communication or if you need assistance in determining the impact of these rules to your specific tax situation, please contact us. We recognize that these are difficult and uncertain times, and we remain committed to supporting you.