Things May Change, But for Now, Expenses Are Non-deductible
By James T. Krupienski, CPA
For many of us, 2020 has been nothing but a new four-letter word. Unemployment has run rampant, long-standing businesses have shuttered their doors, people have gotten sick, and many have lost loved ones. Those businesses remaining open have had to deal with shutdowns, employees on medical leave, and, ultimately, having to create a whole new way of doing business.
To help businesses from a financial standpoint, the U.S. Congress intervened with the CARES Act back in March. A significant component of this act was the creation of the Paycheck Protection Program (PPP), a series of government loans overseen by the Small Business Administration. The most important provision of this program was the premise that, assuming the loan proceeds were used for certain qualified purposes, 100% of the loan proceeds could be forgiven, and would not be considered taxable income.
Since that time, we have seen loan applications come with revisions that quickly followed, clarifications on allowable expenses have been issued, and now many businesses are now starting the process of loan forgiveness. One significant wrinkle was thrown into the process on May 2, when the Department of Treasury issued Notice 2020-32. stating that otherwise-allowed business deductions would be disallowed for tax purposes if the forgiven loan was used to cover those specific costs.
We have all been waiting for further clarification regarding whether this provision would hold and, if it does, when the non-deductible expenses would need to be taken into income. On Nov. 18, this was clarified for all taxpayers, and this article will cover these recent updates.
Will Non-deductibility Be Overturned?
Many taxpayers were in an uproar when the Treasury Department clarified that expenses would not be deductible. In essence, this would lead to an increase in taxable income, which was not the intent of Congress when the CARES Act was passed. There has been some hope that this provision would be overturned.
However, like many other promised stimulus extensions, there has been no forward movement on this in Washington to overturn the Treasury Department’s decision. Therefore, as this article is being written, we can only hope some decision will be made. As of now, we need to proceed as guidance currently stands — that the expenses are non-deductible.
When Do the Non-deductible Expenses Hit the P&L?
There has been lively discussion within the accounting community for months about when the non-deductible expenses would have an impact on each company’s bottom line. One camp was adamant that it would not become income until the loan was forgiven, because what if it wasn’t? The other camp argued that the expenses would be non-deductible as the expense was incurred, assuming a belief that the loan would be forgiven in the future. This can all be put to rest now, as the Department of Treasury ruled on this debate.
Revenue Ruling 2020-27 clarifies that the expenses are disallowed when incurred, assuming that there is ‘reasonable expectation of reimbursement.’ This holds true regardless of whether the taxpayer plans to apply for forgiveness in 2020 or 2021.
With its ruling, the Treasury Department provided two examples. In each, the taxpayer incurred and paid expenses that were qualified expenses per the PPP loan program, and in each, the taxpayers believed they had basis to achieve forgiveness of the loans. In the first example, forgiveness was applied for during November 2020. In the second example, the taxpayer does not expect to apply for forgiveness until 2021.
Given that all expenses were eligible expenses, and given that each taxpayer believes forgiveness is expected, then the deduction as incurred would not be allowed. This would then have an impact on their current-year tax filing. It is critical for all businesses to note that the impact of non-deductibility of their PPP loan expenses will need to be considered when engaged in tax planning for 2020 year-end, which is presently upon us.
What If the Loan Is Subsequently Not Forgiven?
For those taxpayers who either do not have their loan forgiven, or those who do not plan to apply for forgiveness, these expenses will then become deductible. This was addressed by the Treasury Department in a safe harbor under Revenue Procedure 2020-51, issued concurrently with Revenue Ruling 2020-27.
This guidance clarifies that a taxpayer will be able to claim as a deduction, on either their current or subsequent tax return, any expenses now deemed deductible by not achieving forgiveness of the loan, depending on the circumstances. This would occur if forgiveness is declined or not requested.
To request the safe harbor and be able to deduct these expenses, a statement must be attached to the tax return, with a series of required inclusions, along with a heading of “Revenue Procedure 2020-51.”
Where Do We Go from Here?
At this time, everyone who received a PPP loan should be reaching out to their accountant to discuss the impact on their 2020 business return. Strategies will need to be discussed regarding how to handle and best address this increased taxable ‘income’ that will be reported on your business tax return.
For those who were hopeful that the non-deductibility provision would be overturned, all we can do is wait and see if Washington makes any further changes down the road. Stay tuned!
James T. Krupienski, CPA is partner and Auditing, Accounting, Healthcare Services leader at Holyoke-based Meyers Brothers Kalicka; (413) 536-8510.
