IRS PROVIDES SAFE HARBOR FOR DEDUCTING EXPENSES IF PPP LOAN IS NOT FORGIVEN20 November 2020
Rev Proc 2020-51, 2020-50 IRB
In a Revenue Procedure, the IRS has provided a safe harbor allowing a taxpayer to claim a deduction in 2020 for certain otherwise deductible eligible expenses if the taxpayer received a Paycheck Protection Program (PPP) loan which
1. At the end of the taxpayer’s 2020 tax year the taxpayer expects to be forgiven in a tax year after the 2020 tax year, and,
2. In a post-2020 tax year, the taxpayer’s request for forgiveness of the loan is denied, in whole or in part, or the taxpayer decides never to request forgiveness of the loan.
Background. Sections 1102 and 1106 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act, the “Act,” PL 116-136) established the Paycheck Protection Program (PPP) as a loan program administered by the U.S. Small Business Administration (SBA) that was designed to assist businesses adversely impacted by the COVID-19 emergency to pay payroll costs and other eligible expenses.
Under the PPP, the SBA is permitted to guarantee the full principal amount of a covered loan, defined by Act Sec. 1102(a)(2) as a loan made under the PPP during the covered period; a covered loan may be forgiven under Act Sec. 1106.
The covered period is the period beginning on February 15, 2020, and ending on December 31, 2020. (Act Sec. 1102(a)(2), as amended by the Paycheck Protection Program Flexibility Act of 2020 (PL 116-142))
An individual or entity that is eligible to receive a covered loan (eligible recipient) can receive forgiveness of the full principal amount of the covered loan up to an amount equal to the following costs incurred and payments made during the covered period:
1. Payroll costs,
2. Interest on a covered mortgage obligation,
3. Any covered rent obligation payment, and
4. Any covered utility payment (eligible expenses). (Act Sec. 1106(b))
Under Act Sec. 1106(i), for purposes of the Code, “any amount which (but for [Act Sec. 1106(i)]) would be includible in gross income of the eligible recipient by reason of forgiveness described in [Act Sec. 1106](b) shall be excluded from gross income.” Act Sec. 1106(i) excludes the amount from gross income regardless of whether the amount would be
1. Income from the discharge of indebtedness under Code Sec. 61(a)(11), or
2. Otherwise includible in gross income under Code Sec. 61.
Code Sec. 161 provides that, in computing taxable income under Code Sec. 63, certain deductions are allowed.
Rev Rul 2020-27, 2020-50 IRB, holds that a taxpayer computing taxable income on the basis of a calendar tax year may not deduct eligible expenses in its 2020 tax year if, at the end of the 2020 tax year, the taxpayer has a reasonable expectation of reimbursement in the form of covered loan forgiveness on the basis of the eligible expenses it paid or accrued during the covered period. See Revenue Ruling provides guidance on deducting expenses when PPP loan forgiven.
Safe harbor rules. Rev Proc 2020-51, 2020-50 IRB provides two safe harbors to claim deductions for eligible expenses in the 2020 tax year for which no deduction would otherwise be permitted because at the end of the 2020 tax year the taxpayer reasonably expects to receive forgiveness of the covered loan based on those eligible expenses (non-deducted eligible expenses).
Safe harbor for deductions to be claimed in 2020 tax year. An eligible taxpayer (described below) who satisfies the safe harbor requirements (described below) may deduct non-deducted eligible expenses on the taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for the 2020 tax year, or amended return or Administrative Adjustment Request under Code Sec. 6227 for the 2020 tax year, as applicable. (Rev Proc 2020-51, Sec. 4.01)
Safe harbor for deductions to be claimed in subsequent tax year. An eligible taxpayer who satisfies the safe harbor requirements, may deduct non-deducted eligible expenses on the taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for a subsequent tax year (i.e., a tax year after the 2020 tax year). Eligible taxpayers may, but do not need to, use this safe harbor to deduct non-deducted eligible expenses in a subsequent tax year because those taxpayers may deduct the non-deducted eligible expenses in the year that the loan forgiveness is denied under general tax principles, assuming that the taxpayer does not elect to the use the safe harbor above. (Rev Proc 2020-51, Sec. 4.02)
Safe harbor requirements. A taxpayer applying one of the safe harbor procedures may not deduct an amount of non-deducted eligible expenses in excess of the principal amount of the taxpayer’s covered loan for which forgiveness was denied or will no longer be sought. (Rev Proc 2020-51, Sec. 4.03)
A taxpayer may not apply the safe harbor procedures to deduct any amount of non-deducted eligible expenses unless the taxpayer attaches a statement to the return on which the taxpayer deducts non-deducted eligible expenses. The statement must be titled “Revenue Procedure 2020-51 Statement.” The Revenue Procedure provides details of what must be included in the statement. (Rev Proc 2020-51, Sec. 4.04)
Eligible taxpayer. A taxpayer is eligible to apply either of the safe harbors if the taxpayer meets either of the following two requirements.
A taxpayer meets the first requirement if:
1. The taxpayer paid or incurred eligible expenses in the 2020 tax year for which no deduction is permitted because at the end of the 2020 tax year the taxpayer reasonably expects to receive forgiveness of the covered loan based on those eligible expenses;
2. The taxpayer submitted before the end of the 2020 tax year, or as of the end of the 2020 tax year intends to submit in a subsequent tax year, an application for covered loan forgiveness to the lender; and
3. In a subsequent tax year, the lender notifies the taxpayer that forgiveness of all or part of the covered loan is denied. (Rev Proc 2020-51, Sec. 3.01)
A taxpayer meets the second requirement if:
1. The taxpayer meets the requirements of (1) and (2) above; and
2. In a subsequent tax year, the taxpayer irrevocably decides not to seek forgiveness for some or all of the covered loan. For example, a taxpayer that determines that it will not qualify for covered loan forgiveness and withdraws the application submitted to the lender as described in Rev Proc 2020-51, Sec. 3.01. (Rev Proc 2020-51, Sec. 3.02)
Additional limitations. Nothing in the Revenue Procedure precludes the IRS from examining other issues relating to the claimed deductions for non-deducted eligible expenses, including the amount of the deduction and whether the taxpayer has substantiated the deduction claim. It also does not preclude the IRS from requesting additional information or documentation verifying any amounts described in the statement described in Rev Proc 2020-51, Sec. 4.04. (Rev Proc 2020-51, Sec. 4.05)
Effective date. The Revenue Procedure is effective for tax years beginning or ending in 2020. (Rev Proc 2020-51, Sec. 5)