Are PPP Expenses Deductible? No, But…
Ryan McDonell Tax Manager, CPA
30 November 2020
The Paycheck Protection Program (PPP) was implemented as part of the CARES Act back in March of 2020 when uncertainty around COVID-19 was ramping up. PPP provided borrowers with loans equal to 2.5 times the borrowers’ average monthly payroll during 2019. Not only did the PPP offer favorable loan terms such as a low interest rate, deferral of repayment, no borrower fee, and no personal guarantee, but PPP loans were also potentially fully forgivable. If the borrower followed the program requirements by spending proceeds over an 8-week (later, a 24-week) period on payroll, rent, utilities and mortgage interest, then the loan would not have to be repaid by the borrower. The amount of loan forgiveness was subject to reduction if the borrower did not retain employees (measured in full-time equivalents) or reduced the hourly rate/salary of any single employee by more than 25%. Further, the CARES Act explicitly provided that any amount forgiven would be excluded from the borrower’s gross income, essentially making forgiven loan proceeds nontaxable.
Various provisions of the PPP evolved over the succeeding months. Some changes were borrower-friendly while other changes made borrowers reconsider whether the PPP was worth the headaches. One change that remains unresolved is especially relevant to year-end tax planning: the deductibility of PPP expenses.
IRS Notice 2020-32, released on April 30th, 2020, was a gut-punch to the many PPP borrowers who were already busy steering businesses through the COVID-19 crisis. The Notice explained that no deduction would be allowed for expenses paid with PPP proceeds if the PPP loan was forgiven. Some participants viewed the Notice as contradictory. If the CARES Act made forgiven loan proceeds nontaxable, but the expenses paid with the loan were nondeductible, what was the point of the CARES Act provision in the first place?
Others argued the Notice was a necessary means of preventing a double benefit whereby borrowers would not be taxed on loan forgiveness (benefit #1) and yet still would be able to deduct the associated expenses (benefit #2).
Less than a week after Notice 2020-32’s release, a bipartisan letter to Treasury Secretary Mnuchin, dated May 5th 2020, argued that the denial of deductibility was against the congressional intent of the PPP program and urged the Treasury and IRS to reverse the Notice’s position. The letter was signed by Senate Finance Committee Chair Chuck Grassley (R-IA), Finance Committee ranking member Ron Wyden (D-OR), and House Ways and Means Chair Richard E. Neal (D-MA). However, of note, Ways and Means ranking member Kevin Brady’s (R-TX) signature was missing from the letter. On May 13th, Brady contradicted his peers and went as far as to say that there was not a unified congressional intent to make PPP expenses deductible, and if that were the case, deductibility would have been written as part of the PPP. Over the following months, congressmembers made several attempts to restore expense deductibility, all of which were unsuccessful. Notably, for example, deductibility was omitted from the PPP Flexibility Act passed in June of 2020, and Senator John Cornyn’s (R-TX) stand-alone deductibility bill S.3612 failed to gain enough traction despite garnering 35 co-sponsors from both sides of the isle.
So, where do we stand now?
Under the current Trump Administration and Treasury Secretary Mnuchin, there seems to be little hope of the IRS reversing its course on deductibility without legislation forcing the hand. The political climate during the lame duck session (assuming no change to the election results) is not exactly reassuring as the divided government has been unable to reach an agreement on stimulus. Some observers remain hopeful that deductibility will make its way into the inevitable stimulus package or government funding bill, but unfortunately there is no guarantee. Assuming there is a change to a Biden Administration in January, the American Institute of CPAs (AICPA) is confident that there is enough bipartisan and bicameral support to restore deductibility, but again, there is no guarantee.
In the meantime, IRS Rev. Rul. 2020-27 explains that for a borrower with a reasonable expectation of receiving loan forgiveness, PPP expenses are nondeductible in the year incurred or paid, regardless of when the borrower seeks loan forgiveness. This means that a borrower that incurs or pays PPP expenses in 2020 has to add back expenses into income in 2020 regardless of whether the borrower (1) receives loan forgiveness during 2020, (2) applies for forgiveness during 2020 but does not receive forgiveness until 2021, or (3) waits until 2021 to apply for loan forgiveness. Still, some practitioners continue to argue, based on the underlying rationale of the case Hillsboro National Bank v. Commissioner and United States v. Bliss Dairy Inc., that a borrower should be able to wait until 2021 to add the expenses back into income if the borrower does not receive loan forgiveness until 2021.
Okay… so expenses may be added back to 2020 income, may be added back to 2021 income, or may eventually remain deductible – what is the recommendation?
Outside of flipping a 3-sided coin and leaving the decision to chance, taking a position on PPP expenses will ultimately be a business owner’s decision affected by the owner’s risk appetite. The conservative approach is to assume expenses must be added back into income for 2020 and to estimate the business’ and/or owners’ tax liabilities based on that assumption. If taxpayers take this approach and the expenses eventually become deductible, this will reduce taxpayers’ tax liabilities when tax returns are filed. What this means for calendar-year taxpayers paying 4th quarter estimates will be based on the facts and circumstances for businesses and owners, since businesses are not all the same and deal with unique situations.
At this point, we can only hope for more clarity on PPP expense deductibility, even though finding out now may be too little, too late. Hopefully this article has provided some clarity on the ambiguity surrounding PPP expense deductibility. Having frustration over no definitive answer this late in the game is certainly understandable and warranted but remember…don’t shoot the messenger!