DEDUCTIBILITY OF PPP-FUNDED EXPENSES IN THE AIR?
On November 17, 2020, the IRS reiterated its position that taxpayers may not deduct expenses to the extent they result in forgiveness of a Paycheck Protection Program (PPP) loan. The IRS’s position is on based Internal Revenue Code Section 265, which denies a deduction for expenses allocable to tax-exempt income, i.e. the PPP loan forgiven. These expenses include: (1) payroll costs; (2) interest on a business mortgage; (3) rent; and (4) certain utilities. The PPP loan forgiven is expressly excluded from gross income under the CARES Act.
In Rev. Rul. 2020-27, the IRS maintains that businesses that received a PPP loan in 2020 may not fully deduct expenses paid with the loan funds, if they “reasonably expect” the loan to be forgiven in 2021, regardless of whether they have received formal notice of forgiveness, or even applied for forgiveness by the end of 2020.
Companion ruling, Rev. Proc. 2020-51 further provides that if some or all of the PPP loan is not forgiven, the business may deduct the expenses on either an amended 2020 return or on their 2021 return if they attach a statement to their return titled “Revenue Procedure 2020-51 Statement” that discloses the amount of loan that was denied and details the amount of eligible expenses reported on the return.
These pronouncements do not provide any guidance on how to calculate the nondeductible portion of the expenses allocable to a forgiven PPP loan. They seem to view a forgiven PPP loan as a “reimbursement” of the expenses incurred. However, that is not an accurate comparison because the expenses are used only to determine eligibility for the forgiveness and not to be reimbursed. Moreover, in most cases, the salaries would have been incurred anyway and are actively generating other revenue for the business that is fully subject to tax.
Existing IRS regulations under Section 265 provide that “If an expense…is indirectly allocable to both a class of nonexempt income and a class of exempt income, a reasonable proportion thereof determined in light of all the facts and circumstances in each case shall be allocated to each.” Reg. § 1.265-1(c). Therefore, if salaries are generating both taxable and nontaxable income, the existing regulations permit the expenses to be allocated between the two classes of income and those expenses that are allocable to taxable income remain fully deductible.
In the meantime, the American Institute of CPAs is asking its members to contact their representative or senators to urge that the House of Representatives and the Senate include legislation allowing a full deduction for PPP eligible expenses. Specifically, the AICPA supports the passage of S. 3612 and of H.R. 6821, Small Business Expense Protection Act of 2020, or of H.R. 6754, Protecting the Paycheck Protection Program Act of 2020 and is providing language members can use to write their senators and representatives to influence Congress to act.