Congress made its original intention clear – the PPP was to be a forgivable loan that, upon forgiveness, would generate tax-free income. The IRS had other plans.
Based on an existing tax concept (that Congress failed to address), the IRS casually pointed out that any expenses that arise in generating tax-free income should themselves be non-deductible to avoid a double-tax-benefit. On November 18th the IRS released Revenue Ruling 2020-27 to cement what we had all been expecting.
How does this affect my PPP?
The PPP forgiveness will, in effect, not be tax-free. While the forgiveness is technically non-taxable income, the tax-free forgiveness of debt will be offset (from a tax perspective) by the wages and expenses that were used to qualify for PPP forgiveness becoming non-deductible.
In other words, if you received a PPP of $20,000 and it was fully forgiven, your taxable profit for 2020 will be increased by $20,000.
Why is my 2020 taxable income going up if my forgiveness isn’t coming through until 2021?
This is the real meat of the Revenue Ruling released yesterday. The IRS confirmed what we had suspected, which is that the expenses associated with the forgiveness of the PPP must be shown as non-deductible on the 2020 tax return if there is a reasonable expectation that the PPP will be forgiven in the future.
“If a business reasonably believes that a PPP loan will be forgiven in the future, expenses related to the loan are not deductible, whether the business has filed for forgiveness or not. Therefore, we encourage businesses to file for forgiveness as soon as possible,” said a Treasury statement.
The IRS provides two example scenarios in the revenue ruling:
- A borrower applies for forgiveness in November 2020 and satisfied all of the requirements for forgiveness, but they haven’t yet received an answer as to whether or not their loan will be forgiven
- A borrower spent their PPP funds according to the criteria laid out in the CARES Act but has not yet applied for forgiveness, though they plan to in 2021
In both of these examples the taxpayer cannot deduct expenses funded with PPP loans because they have a reasonable expectation of forgiveness at some point in the future.
What if I applied for forgiveness but it was later rejected?
The IRS released Rev. Proc. 2020-51 providing a safe harbor to allow taxpayers that submitted their loan forgiveness application in 2020 that was fully or partially denied in 2021 to deduct these expenses on their 2020 tax return or in a subsequent year.
Now that the dust seems to be settling around PPP forgiveness (at least for the moment), the Treasury is encouraging borrowers to submit their forgiveness applications ASAP so that they can act accordingly when filing their 2020 tax returns. That said, given the track record surrounding the PPP’s rules, further changes are certainly possible, so there may be wisdom in not rushing into your forgiveness application just yet. Not sure about this process? We can help you navigate the PPP forgiveness, give us a call!
Note – the years shown above apply to calendar year taxpayers. If you are a fiscal year taxpayer these may differ for you.
This is a complicated and developing area of the tax code. Always consult your tax advisor before making any decisions.