IRS Clarifies Deductibility and Timing for PPP Related Expenses

On Wednesday, November 18, 2020 the IRS released guidance regarding the deductibility and timing of covered expenses that resulted from the use of funds provided through the Paycheck Protection Program.  The guidance, in part, reads “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.”  

The guidance includes links to a related revenue ruling and revenue procedure. 

In the revenue ruling, the Service states “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.”

The guidance released today addresses two questions business owners have been asking for several months:

Q1) What is the business income tax implication of the Paycheck Protection Program? 

A1) The IRS has clarified their position and will not allow covered expenses paid with PPP funds to be deducted for income tax purposes.  If a borrower used all of their PPP funds on covered expenses, that amount will not be deductible, effectively resulting in an increase of taxable income.  Any portion of a PPP loan that was not used on covered expenses and is not expected to be forgiven will not impact the deductibility of those expenses and will not impact taxable income.  

Q2) What is the impact on the 2020 tax year if the borrower has not filed for or received PPP loan forgiveness? 

A2) If the covered expenses were paid or accrued during the covered period and, at the end of the tax year the borrower expects to receive forgiveness,  those expenses are not deductible in the current year.  Based on the timing of most loans, the majority of borrowers whose PPP funds were spent on covered expenses will not be able to deduct these expenses for tax year 2020.

While not favorable news for borrowers, today’s developments simply clarify what has been widely expected as the IRS position on timing and deductibility.  Congress has brought forward legislation that would resolve the deductibility issue for borrowers.  The legislation has yet to pass, however Congress still has time to act and add deductibility back for tax year 2020.  Please consult your CPA or tax professional for further guidance and clarification.  HCP will continue to provide information as it become available.