Expenses Used for PPP Loan Forgiveness Deductible on 2020 Returns
The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act provided Paycheck Protection Program (“PPP”) loans to employers with 500 or fewer employees. These loans could be fully forgiven if used for certain expenses during the covered period. When originally enacted, Congress specified that the forgiveness of indebtedness would not be taxable, but did not address whether the otherwise deductible business expenses paid for with PPP loan proceeds continued to be tax deductible if the expenses were used as the basis for loan forgiveness.
IRS Notice 2020-32, released on April 30, 2020, set forth the IRS position and stated that expenses were not deductible because the expenses used for loan forgiveness were a class of income related to the tax-exempt proceeds of the PPP Loan. Revenue Ruling 2020-27, released on November 18, 2020, amplified the Notice providing that no deduction was allowed if the taxpayer had a reasonable expectation that a PPP loan would be forgiven. Both of these releases were very controversial and a number of practitioners believed taxpayers could take a tax return position that the amounts were deductible. For more information on this subject, review, the Journal of Accountancy article, “Expenses used for PPP Loan Forgiveness: Deductible or not?” by Deborah Walker, CPA, and Barry M. Weins, CPA, J.D., Cherry Bekaert LLP.
Many in Congress stated that the expenses should be deductible and made this clear in the Consolidated Appropriations Act (“CAA”), 2021. By statute, expenses used for the forgiveness of PPP loans are deductible and the forgiveness of indebtedness remains nontaxable. This overturns the holdings in Notice 2020-32 and Revenue Ruling 2020-27. As a result, employers that received PPP loans and used those loans to pay otherwise deductible business expenses may claim a deduction for those expenses on 2020 tax returns, even if the employer has received or expects to receive forgiveness of their PPP loan.
In addition, the CAA addresses how forgiveness would be treated for partners and S corporation shareholders who would be entitled to the deduction for these expenses. For partnerships and S corporations, the amounts are treated as tax-exempt income and thus, to the extent of the deductible expenses, increase a partner’s or shareholder’s basis. The basis adjustment occurs when the forgiveness occurs which is often the year following the year in which the expenses are deducted. This can result in a partner or shareholder not having basis to fully realize the benefit of the deductions. PPP loans are nonrecourse and thus cannot be used to increase basis. In addition, changes in ownership means that the basis adjustment and the expense deduction may not be for the same individual. The tax-exempt income will increase earnings and profits for C corporations.