Paycheck Protection Program (PPP) loans were designed to provide a life raft for business owners struggling in the wake of the COVID-19 pandemic. As most small-business clients have already learned, PPP loan forgiveness is very much a “some strings attached” process. Those strings include forgoing valuable business expense deductions — possibly leading to a hefty tax bill in 2021.
However, not all loan recipients are in the same boat. The IRS has recently released a two-pronged set of guidance for determining whether — and when — small-business owners might be entitled to deduct business expenses despite the generally applicable “no double dipping” rule.
Expecting Loan Forgiveness? Forget the Business Expense Deductions
The IRS guidance confirms that PPP loan recipients who have a reasonable expectation that they will have loan amounts forgiven cannot deduct otherwise eligible business expenses. The rationale behind this “no double dipping” rule is that forgiven PPP loans are not included in the business’ income under normal cancellation of debt rules.
Expenses like salary, rent, mortgage interest and utilities are generally deductible as ordinary and necessary business expenses under IRC Section 162. These are also exactly the types of expenses that can be incurred in order for a business to receive loan forgiveness under the CARES Act.
A client who received a covered loan guaranteed under the PPP can’t deduct otherwise deductible expenses if, at the end of such taxable year, the client reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period.
That’s true even if the client has not yet submitted an application for forgiveness of the covered loan by the end of the tax year.
This is a broader than anticipated extension of the no-deductibility rule. In short, it means that taxpayers won’t be able to deduct business expenses even if they haven’t taken any steps toward obtaining loan forgiveness by the end of 2020, as long as they plan to apply for forgiveness.
It’s also uncertain whether this will be the final rule on the issue. Many members of Congress have expressed a desire to take action and prevent this result. Given current political uncertainties, however, it’s far from certain that Congress will act quickly enough to give business owners the certainty they need by tax time.
Safe Harbor Rules: When Business Expense Deductions Are Permitted
The IRS also released a safe harbor for certain business clients whose application for forgiveness was denied or who opt to forgo applying for forgiveness. The safe harbors allow a business to claim a deduction in the 2020 tax year for certain otherwise deductible eligible expenses under two sets of circumstances.
The deduction may be allowed if (1) the eligible expenses are paid or incurred during the taxpayer’s 2020 tax year; (2) the taxpayer receives a PPP loan, which at the end of the 2020 tax year the taxpayer expects to be forgiven in a subsequent tax year; and (3) in a subsequent tax year, the taxpayer’s request for forgiveness of the covered loan is denied, in whole or in part, or the taxpayer decides never to request forgiveness of the covered loan.
Clients who satisfy those three conditions have the option of deducting the expenses on a 2020 income tax return, amended return or AAR for 2020. They can also deduct previously non-deducted expenses in a subsequent tax year (which might be the only option if the loan forgiveness application was eventually denied).
The client must also attach a statement to the return on which the expenses are deducted. That statement includes the client’s personal information, information about the loan amount and information about the amounts that were not forgiven (or the amount for which the client did not ask for forgiveness).
The new IRS rules add yet another layer of complexity to the already-complex PPP loan program. While it seems that this was exactly what Congress sought to avoid, the IRS rules are the law of the land for the moment. It’s important for all business owners to carefully evaluate their own circumstances to determine whether it’s wise or necessary to seek forgiveness under the current rules.
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