IRS Doubles Non-Deductibility of P3-Funded Expenses
In guidelines released late Wednesday, the IRS reiterated its position that taxpayers cannot claim a deduction for any otherwise deductible expense if payment of the expense results in the release of a loan from the Check Protection Program. payroll (PPP) because the income associated with the discount is excluded. from gross income under the CARES Coronavirus Aid, Relief and Economic Security Act, PL 116-136. The directives took the form of a tax decision (Rev. Rul. 2020-27), which addresses the issue of borrowers who pay expenses in 2020 but whose PPP loan is not canceled before 2021, and a revenue procedure (Rev. Proc. 2020-51) which provides a safe haven for PPP borrowers whose loan forgiveness is declined or who choose not to request loan forgiveness.
Under Section 1106 (b) of the CARES Act, an eligible beneficiary of a covered PPP loan may receive debt relief on the loan in an amount equal to the sum of payments made for the following expenses during of the covered period starting on the covered loan. date of creation: (1) personnel costs; (2) any payment of interest on any covered mortgage bond; (3) any payment on any covered rent obligation; and (4) any covered public service payment. Section 1106 (i) excludes from gross revenue any amount remitted under the P3.
In May, the IRS issued Notice 2020-32, providing that a taxpayer who receives a P3 loan is not allowed to deduct expenses that are normally deductible under the Code as long as payment of these expenses results in a forgiveness of the loan under CARES. Act.
The CARES Act itself does not address whether deductions otherwise permitted under the Code for the payment of eligible expenses under Section 1106 of the CARES Act by a recipient of a covered loan are permitted if the covered loan is subsequently canceled. The AICPA believes that the IRS’s interpretation of denying waived expense deductions under the P3 program is contrary to Congress intent.
Expenses paid one year before loan forgiveness
Rev. Rul. 2020-27 addresses the issue of whether a taxpayer who received a PPP loan and who paid or incurred certain otherwise deductible expenses can deduct those expenses in the tax year in which the expenses were paid or incurred if, at the end of that taxation year, the taxpayer reasonably expects to receive forgiveness of the covered loan based on the otherwise deductible expenses.
The Income Decision addresses two situations in which a taxpayer receives a P3 loan in 2020 and pays expenses, including payroll, mortgage interest, and rent, which are eligible expenses under Section 1106 ( a) of the CARES Act. In one situation, the taxpayer requests the forgiveness of the PPP loan (and knew the amount of eligible expenses) in November 2020 but was not informed by the lender at the end of 2020 whether the loan will be canceled. In the second case, the taxpayer did not request the loan forgiveness at the end of 2020 but knew the amount of eligible expenses.
The IRS says that in both cases, the taxpayer has a reasonable expectation of repayment (in the form of loan forgiveness) at the end of 2020; therefore, the expense deduction is not appropriate.
The IRS cites Sec. 265 (a) (1), which prohibits a deduction for otherwise eligible expenses to the extent that payment of such eligible expenses is attributable to tax-exempt income in the form of a reasonably expected guaranteed loan forgiveness. The IRS says that “the fact that the tax-exempt income may not have been accrued or received at the end of the tax year does not change this result because the rejection applies whether or not it is an amount of tax-exempt income in the form of the covered loan cancellation and to which the qualifying expenses are attributable is received or recognized. “
Safe Harbor where the loan is not canceled
In Rev. Proc. 2020-51, the IRS issued safe-haven rules that allow a taxpayer to claim a deduction in the taxpayer’s 2020 tax year for certain qualifying 2020 expenses otherwise deductible if the taxpayer received a PPP loan that the taxpayer expects to be canceled after their 2020 tax year and in a subsequent year, the taxpayer is refused forgiveness of their PPP loan, in whole or in part, or the taxpayer decides not to request the delivery of a PPP loan. In this situation, as part of the safe harbor of tax proceedings, the taxpayer may deduct some or all of the expenses on (1) a timely filed original tax or information return (including extensions) for the 2020 tax year, (2) an amended 2020 return or administrative adjustment request, or (3) an original income tax or information return filed in a timely manner for the following tax year.
To benefit from the safe harbor, taxpayers must attach to their declaration a declaration entitled “Declaration of tax procedure 2020-51” which contains:
- The name, address and social security number of the taxpayer or the identification number of the employer;
- A statement specifying whether the taxpayer is an eligible taxpayer under section 3.01 of the tax procedure, for a taxpayer who requested loan forgiveness in 2020 (or at the end of the 2020 tax year intended to request the loan forgiveness in a subsequent tax year) and the request was refused in whole or in part, or under section 3.02, for a taxpayer who requested a loan forgiveness in 2020 (or at the end of the year tax 2020 intended to request loan forgiveness in a subsequent tax year) but in a subsequent tax year decides to irrevocably withdraw his pardon request;
- A statement that the taxpayer is applying the safe harbor of section 4.01 of the tax procedure for expenses claimed in 2020 or section 4.02 for expenses claimed in a subsequent year
- The amount and date of disbursement of the taxpayer’s loan;
- The total amount of the guaranteed loan forgiveness that the taxpayer was refused or decided not to ask for;
- The date on which the taxpayer was refused or decided to no longer request the surrender of a guaranteed loan; and
- The total amount of eligible expenses and non-deducted eligible expenses that are reported on the return.
Nothing in the tax process prevents the IRS from reviewing tax returns to determine whether taxpayers are eligible to deduct the expenses in question.
The procedure is effective for tax years starting in 2020.
For more information and stories on the coronavirus and how CPAs can handle the challenges of the outbreak, visit the JofAof coronavirus resource page or subscribe to our email alerts for the latest P3 news.
For tax resources, visit the AICPA website COVID-19: Tax resource page.
– Sally P. Schreiber, JD, ([email protected]) is a JofA editor-in-chief.