Guidance released by the IRS on November 18, 2020 affects taxpayers who have received Payroll Protection Program (PPP) loans. Unfortunately, at least for the time being, the guidance has dashed hopes of PPP loans being forgiven tax-free. The never-ending PPP saga will continue to evolve in the coming months, however, so we believe it is too soon to panic. Read on for our answers to frequently asked questions about the guidance and its impact on year-end tax planning for PPP loan recipients.
Didn’t the IRS previously warn us about loans being taxable?
Well, sort of. Technically the receipt of the loan is not taxable; however, in May 2020 the IRS released Notice 2020-32 which, in plain English, disallows deductions for expenses that were paid using PPP loan proceeds and ultimately forgiven (i.e., wages, rent, interest paid, utilities). As a result, disallowed deductions for expenses funded with PPP loan proceeds is equivalent to having the forgiven loan treated as income.
But I thought taxpayers having a December 31 year-end could ignore this tax issue for 2020 and re-evaluate things in 2021.
RKL and many other firms have been advising clients that the triggering event that makes expenses nondeductible occurs when the SBA formally forgives the PPP loan. For some calendar year-end PPP loan recipients, formal SBA forgiveness may occur after December 31, 2020. Therefore, the PPP loan is still just that – a loan – at year-end. As a result, the argument is that until the loan is formally forgiven there can be no disallowed expenses paid with tax-exempt loan proceeds.
That makes complete sense, but I have a sneaking suspicion the recent guidance from the IRS must have messed up this plan!
You could say that! Revenue Ruling 2020-27 elaborated on previous IRS guidance to provide taxpayers with what the Treasury describes as “greater clarity and flexibility.” The ruling specifically addresses two situations. In situation one, the borrower applies for forgiveness in November 2020, but, as of December 31, 2020, has not been informed by the lender whether the loan will be forgiven. The IRS guidance indicates that if the taxpayer has a reasonable expectation of loan forgiveness, then no deduction is allowed for the expenses in 2020. Notably, the IRS makes no delineation in their stance regardless of whether the amount of the PPP loan is above $2 million and therefore subject to added SBA audit scrutiny.
This news isn’t great, but I think I can still outsmart the IRS on this one! How about I just wait to apply for forgiveness until January 2021, and then I can avoid paying extra tax in 2020 from disallowed expenses, right?
The IRS is one step ahead of us on this! Remember that I mentioned Revenue Ruling 2020-27 describes two situations? The second situation is identical to the first, except the taxpayer waits until 2021 to request loan forgiveness. The IRS argues that if the taxpayer continues to believe “loan forgiveness is reasonably expected to occur,” then the taxpayer may not deduct the related expenses in 2020, even if they do not begin the loan forgiveness process until 2021. If you think this standard seems mighty nebulous and potentially difficult to interpret and apply, we agree!
Is there any good news from the IRS guidance released last week?
Maybe just a bit! Revenue Procedure 2020-51 provides safe-harbor rules that allow a taxpayer to claim a deduction for expenses in 2020 if the taxpayer decides not to request loan forgiveness, or if forgiveness is requested but subsequently denied in whole or part by the SBA. If this occurs, the taxpayer has the option to write off the expenses on an originally filed 2020 tax return, an amended 2020 return or a subsequent tax year’s return.
So let me get this straight…you’re saying if I received a PPP loan, spent the money on qualified expenses, and, regardless of whether I already applied for forgiveness or simply intend to apply for forgiveness in 2021, then I cannot write off the related expenses on a 2020 tax return? That will significantly increase my 2020 taxes!
Yes, unfortunately, that is likely the result under Revenue Ruling 2020-27.
This makes me mad! When Congress passed the CARES Act, they talked about the money being tax-free. I don’t understand how the IRS can do this!
Various elected officials from both parties have stated on the record that the IRS guidance released in May, and reaffirmed more strongly in November, is not consistent with Congressional intent around the CARES Act. Unfortunately, it will literally require an act of Congress to override the IRS’s current position disallowing expenses paid with PPP funds.
So what is Congress doing about this now that the IRS has doubled down on their nondeductible expense position?
Here’s the best news yet. The Senate Finance Committee Chairman Chuck Grassley (R-Iowa) and Ranking Member Ron Wyden (D-Oregon) released a joint statement headlined “Treasury Misses the Mark on PPP Loan Expense Deductibility Guidance.” It is especially notable that bipartisan support exists to fix the law and thereby render the IRS’s current position irrelevant.
When might Congress fix this?
Bloomberg News reports that lawmakers have said they are working to include language in year-end legislation fixing the nondeductible expense issue created by forgiven PPP loans. This fix could be included in government spending legislation that Congress must pass by December 11 before federal funding runs out.
What if Congress fails to act and the current IRS guidance remains intact?
We believe the IRS’s recent guidance creates increased urgency for Congress to act. Therefore, in the short-term we suggest patience.
In the absence of Congressional action, then typical year-end tax planning strategies should be evaluated which may include deferring income (if possible) and accelerating expenses. Taxpayers should ensure they are claiming all available tax credits, maximizing depreciation deductions and evaluating tax accounting method changes, which are among the most common approaches to minimize current year taxes.
When would I need to pay the taxes owed if the law remains as it is now?
For federal tax purposes, taxpayers may wish to fully pay their 2020 safe harbor estimates (computed based upon 2019 taxes) by the fourth quarter estimated tax payment deadline of January 15, 2021. Then any remaining tax due to the IRS could be paid on April 15, 2021.
Keep your fingers crossed that our representatives in Congress will resolve this issue. In the meantime, contact your RKL advisor for a tailored review of your specific tax situation and related tax planning opportunities.