The Internal Revenue Service recently released Revenue Ruling 2020-27 and Revenue Procedure 2020-51, which provide guidance on the deductibility of certain expenses paid or incurred in a taxpayer’s business using loan proceeds from a “covered loan” provided under the CARES Act’s Paycheck Protection Program.
Under the CARES Act, the principal amount of a covered loan that is used to pay eligible expenses during 2020 may be forgiven to the extent of the eligible expenses, and the amount forgiven is not treated as gross income for the borrower. Very generally, Revenue Ruling 2020-27 confirms that a borrower may not deduct an otherwise deductible expense in its 2020 taxable year if, at the end of the 2020 taxable year, the borrower reasonably expects to be reimbursed for those expenses as a result of forgiveness of a covered loan, even if the borrower has not yet submitted an application for forgiveness of the covered loan. Revenue Procedure 2020-51 provides safe harbors that allow borrowers to take deductions for certain expenses paid for or incurred with proceeds from a covered loan when it is understood that all or part of the covered loan will not be forgiven.
For more information on Paycheck Protection Program (PPP) loan forgiveness and the application for forgiveness, read our LawFlash, CARES ACT: Paycheck Protection Program Provides Small Business Loans to Support Employees.
Amplifying guidance provided in Internal Revenue Service (IRS) Notice 2020-32, discussed in our May 6, 2020 LawFlash, Revenue Ruling 2020-27 considers two scenarios involving a borrower that is a calendar year taxpayer that received a covered loan under the PPP. In both scenarios, the borrower pays during its 2020 tax year certain payroll costs, mortgage interest, utility payments, and rents that are treated as “eligible expenses” under the CARES Act. In the first scenario, the borrower applies for forgiveness of the loan in November 2020, but the borrower does not receive confirmation before the end of 2020 that the loan will, in fact, be forgiven. In the second scenario, the borrower does not apply for forgiveness of the loan in 2020, but expects to apply for forgiveness in 2021. In both scenarios, the amount of eligible expenses is known and the borrower has a reasonable expectation that the loan will ultimately be forgiven. Revenue Ruling 2020-27 holds that under either of the above scenarios, the borrower may not deduct the eligible expenses in computing its taxable income for the 2020 tax year if, at the end of the tax year, the borrower reasonably expects to receive forgiveness of the covered loan.
The two scenarios in the ruling also illustrate the IRS’s position that a borrower should be considered to have a reasonable expectation of forgiveness if it used the proceeds from a covered loan for eligible expenses described in the CARES Act and otherwise satisfied the requirements under the CARES Act for forgiveness, due to the presence of “clear and readily accessible guidance to apply for and receive covered loan forgiveness.”
Revenue Procedure 2020-51 provides a safe harbor for certain borrowers that are partially or fully denied forgiveness of a covered loan and borrowers that never make a claim for forgiveness of a covered loan (or withdraw a claim), including borrowers that had previously reasonably expected to receive forgiveness of a covered loan.
Specifically, under the safe harbor a borrower may claim a deduction in the borrower’s taxable year beginning or ending in 2020 (the 2020 taxable year), or a subsequent taxable year, for certain otherwise deductible eligible expenses if all of the following occur:
If a borrower meets the above requirements, it may be able to deduct some or all of the eligible expenses on (1) the borrower’s timely filed, including extensions, original income tax or information return for the 2020 taxable year; (2) an amended return or an administrative adjustment request (AAR) under Section 6227 for the 2020 taxable year; or (3) the borrower’s timely filed, including extensions, original income tax or information return for the subsequent tax year.
A borrower may not apply the safe harbor procedures to deduct any amount of non-deducted eligible expenses unless the borrower attaches a statement to the return on which the borrower deducts non-deducted eligible expenses. The statement must be titled “Revenue Procedure 2020-51 Statement,” and must include the information outlined in the revenue procedure.
The flexibility to deduct certain expenses in a subsequent tax year under the safe harbor may be helpful to certain borrowers that may not need the benefit of the deduction in the 2020 taxable year.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Daniel A. Nelson
George P. Mair
Kenneth S. Kail
Richard S. Zarin
Andrew T. Budreika
Daniel F. Carmody
Benjamin W. Stango
Barton W.S. Bassett
Michael D. Kummer
James G. Steele III