Are The Expenses Paid By PPP Loan Deductible?
The IRS has a long history of providing answers to taxpayers' questions that creates more confusion and raises even more questions! Deductibility of PPP-paid expenses is one of them.
Since the government started to pay Paycheck Protection Program (PPP) loans as part of the CARES Act back in April to small businesses to cover their expenses, there were speculations that whether the expenses paid by these loans can be deducted on the 2020 tax return or not. The IRS finally published Revenue Ruling 2020-27 to "answer" this question. The official position of the IRS is that expenses paid by PPP loans are NOT deductible IF at the time of filing the tax return the taxpayer "reasonably expects to receive a forgiveness" for the loan.
Based on this ruling, it does not matter if the taxpayer has already applied for the loan forgiveness or not. What matters is whether the taxpayer has a sixth sense and can see the future in which his loan is going to be forgiven or not, and based on the Taxpayers' prophecy, one can determine whether such expenses are deductible or not. So, if you expect to receive a loan forgiveness, even though you have not even applied for it yet, or even if you receive the forgiveness in 2021, on your 2020 tax return you cannot deduct your expenses that were paid by the PPP loan (expenses that are ordinary and necessary for the business, and otherwise would be deductible under normal circumstances). The IRS, however, does not provide a guideline or training for developing this sixth sense to see into the future. So it would be up to you to decide that (yes, you can argue that at the time of filing your 2020 tax return, you reasonably expected not to receive a forgiveness, therefore deducted all of your expenses in 2020. But keep in mind that if and when you receive forgiveness, you will have to add back the deductions, and possibly add interest and penalty to them). To make matters worse, the Taxpayer could get a partial forgiveness, so there are infinite number of scenarios that the Taxpayer must guess before deciding how much of their expenses to deduct in 2020!
Since the government started to pay Paycheck Protection Program (PPP) loans as part of the CARES Act back in April to small businesses to cover their expenses, there were speculations that whether the expenses paid by these loans can be deducted on the 2020 tax return or not. The IRS finally published Revenue Ruling 2020-27 to "answer" this question. The official position of the IRS is that expenses paid by PPP loans are NOT deductible IF at the time of filing the tax return the taxpayer "reasonably expects to receive a forgiveness" for the loan.
Based on this ruling, it does not matter if the taxpayer has already applied for the loan forgiveness or not. What matters is whether the taxpayer has a sixth sense and can see the future in which his loan is going to be forgiven or not, and based on the Taxpayers' prophecy, one can determine whether such expenses are deductible or not. So, if you expect to receive a loan forgiveness, even though you have not even applied for it yet, or even if you receive the forgiveness in 2021, on your 2020 tax return you cannot deduct your expenses that were paid by the PPP loan (expenses that are ordinary and necessary for the business, and otherwise would be deductible under normal circumstances). The IRS, however, does not provide a guideline or training for developing this sixth sense to see into the future. So it would be up to you to decide that (yes, you can argue that at the time of filing your 2020 tax return, you reasonably expected not to receive a forgiveness, therefore deducted all of your expenses in 2020. But keep in mind that if and when you receive forgiveness, you will have to add back the deductions, and possibly add interest and penalty to them). To make matters worse, the Taxpayer could get a partial forgiveness, so there are infinite number of scenarios that the Taxpayer must guess before deciding how much of their expenses to deduct in 2020!
Unanswered Issues
Beside the problem mentioned above, there are three main issues with regard to the deductibility of PPP-paid expenses as of this writing (11/24/2020). First, what if the taxpayer determines the amount of the loan forgiveness wrong in 2020. He probably should either amend the 2020 tax return, or adjust the missed/extra deductions taken in 2020 in his 2021 tax return. To avoid this, the best solution is to apply for the loan forgiveness as soon as possible, and if by the time of filing your 2020 tax return (March/April 15) you are not notified about the status of your forgiveness application yet, apply for a 6 month extension to file. Hopefully before the September/October 15 deadline you will find out whether and how much of your PPP loan has been forgiven and then you can determine how much deduction you can take accordingly.
Second, how are self-employed taxpayers filing a Schedule C are supposed to treat their expenses? Since forgiveness of PPP proceeds for a self-employed taxpayer (Sch C filers) is predicated not on how the loan proceeds were spent in 2020 — as it is for all other taxpayers — but instead is a purely a mathematical equation based on the taxpayer’s 2019 income from the business. If the expenses paid by the PPP loan money is not directly related to the forgiveness amount, how much of the Sch C taxpayer's expenses are deductible. Unfortunately, the IRS has not provided any guideline for this situation yet.
Third, let's say the Taxpayers decides to play safe and "reasonably expects" to get his entire PPP loan forgiven, and his expenses are more than the loan amount. Does he get to choose which expenses are deductible, or does he have to prorate all of his expenses? This is very important, as it effects the Section 199A deductions, and again the IRS has not provided any guideline for this. To illustrate this, let's assume you received $50,000 PPP loan and you incurred the following ordinary and necessary expenses in 2020:
Second, how are self-employed taxpayers filing a Schedule C are supposed to treat their expenses? Since forgiveness of PPP proceeds for a self-employed taxpayer (Sch C filers) is predicated not on how the loan proceeds were spent in 2020 — as it is for all other taxpayers — but instead is a purely a mathematical equation based on the taxpayer’s 2019 income from the business. If the expenses paid by the PPP loan money is not directly related to the forgiveness amount, how much of the Sch C taxpayer's expenses are deductible. Unfortunately, the IRS has not provided any guideline for this situation yet.
Third, let's say the Taxpayers decides to play safe and "reasonably expects" to get his entire PPP loan forgiven, and his expenses are more than the loan amount. Does he get to choose which expenses are deductible, or does he have to prorate all of his expenses? This is very important, as it effects the Section 199A deductions, and again the IRS has not provided any guideline for this. To illustrate this, let's assume you received $50,000 PPP loan and you incurred the following ordinary and necessary expenses in 2020:
- $40,000 interest expenses,
- $10,000 repair and maintenance, and
- $50,000 W-2 wages.
What Is Next?
If by the time of fling your 2020 tax return the IRS has not provided a clear guideline regarding these issues, my two cents on these gray areas, as always, is to take the position that is the most beneficial to you.
For more information about PPP loan forgiveness and the treatment of your business expenses in 2020, please contact us at Info@qtaxservices.com or (424) 888-3878.
For more information about PPP loan forgiveness and the treatment of your business expenses in 2020, please contact us at Info@qtaxservices.com or (424) 888-3878.