On November 18, 2020, the IRS issued Revenue Ruling 2020-27 and Revenue Procedure 2020-51. The issuance of these documents follows the IRS’s issuance of Notice 2020-32 on April 30, 2020. As expected, this recent guidance hews to the analysis in the Notice and denies a deduction for expenses related to PPP loan forgiveness regardless of whether the borrower applies for loan forgiveness, or receives a decision on its application for loan forgiveness, in 2020. The relevant inquiry is whether a borrower has a reasonable expectation of reimbursement (i.e., loan forgiveness) as of the end of its taxable year.
In the published ruling, the IRS stated that expense disallowance occurs in 2020 if, at the end of the taxable year, the PPP borrower “reasonably expects to receive forgiveness of the covered loan based on the otherwise deductible expenses.” The ruling posits two scenarios, and in both cases the borrower believes it satisfies all the requirements for loan forgiveness under the CARES Act: (i) the borrower applies for loan forgiveness in 2020 but does not receive a decision from its lender until 2021 and (ii) the borrower does not apply for loan forgiveness in 2020 but expects to apply in 2021.
In both cases, the IRS ruled that expense disallowance occurs in 2020, effectively making the PPP loan forgiveness amount taxable in 2020. The IRS noted that in both cases, the borrowers had a reasonable expectation of reimbursement as of the end of 2020; presumably the result would be different if that were not the case.
The holding of the ruling is as follows: “A taxpayer that received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act may not 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 on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.”
So what does this mean? Practically, it means that the vast majority of borrowers will have expense disallowance in 2020 rather than in 2021. Because the IRS standard is whether a borrower “reasonably expects to receive forgiveness,” a borrower would be hard pressed to assert it had no reasonable expectation of forgiveness if it files or plans to file an application for forgiveness with its lender, under penalties of perjury. After all, other than the uncertainties regarding the loan eligibility issue, the payment of expenses and whether there were headcount or wage reductions are within the borrower’s exclusive knowledge and control.
The revenue procedure provides a flexible safe harbor for borrowers who decide never to apply for loan forgiveness, or who apply for forgiveness but have the request denied in whole or in part in a subsequent tax year. In both cases, borrowers can deduct the relevant expenses on (i) a timely filed, including extensions, tax return for 2020, (ii) an amended tax return for 2020 or an administrative adjustment request (AAR) for 2020, as applicable, or (iii) a timely filed tax return for 2021 if a statement is filed with the 2021 tax return (see below).
Taxpayers eligible for the safe harbor include those (i) who incur eligible expenses in 2020 and reasonably expect loan forgiveness at the end of 2020, (ii) apply for loan forgiveness in 2020 or intend to apply in 2021, and (iii) either (a) learn in 2021 that their loan forgiveness application has been denied in whole or in part or (b) decide in 2021 not to seek loan forgiveness for some or all of their PPP loan (e.g., they determine they will not qualify).
If a taxpayer is eligible for the safe harbor and chooses not to deduct the expenses on an original or amended 2020 tax return, then it can deduct the expenses on its 2021 tax return if it attaches a statement to the return titled “Revenue Procedure 2020-51 Statement,” and includes the following information: