On April 22, the IRS released Revenue Procedure 2021-20, which provides a safe harbor allowing certain Paycheck Protection Program (PPP) loan recipients that did not deduct otherwise deductible expenses paid or incurred during the taxpayer’s taxable year(s) ending after March 26, 2020, and on or before Dec. 31, 2020 (2020 taxable year), to deduct these expenses on their return for the subsequent taxable year.
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), enacted on March 27, 2020, established the PPP to provide loans to small businesses nationwide that were adversely affected by the COVID-19 pandemic. The PPP was amended and expanded in subsequent COVID-19 relief legislation. A PPP loan recipient may receive forgiveness of up to the full principal amount of the loan based on meeting certain requirements, including certain rules on the use of the funds for permissible payroll and nonpayroll costs (eligible expenses), during the PPP covered period.
The CARES Act provides that amounts otherwise includible in the PPP loan recipient’s gross income by reason of loan forgiveness are excluded from gross income. However, the CARES Act did not address whether a deduction is allowed for an otherwise deductible expense if the payment of the expense resulted in forgiveness of the PPP loan.
Notice 2020-32, issued on May 18, 2020, provided that no deduction would be allowed under IRC Section 265(a)(1) and U.S. Department of the Treasury Regulation Section 1.265-1 for amounts allocable to one or more classes of income other than interest wholly exempt from the taxes imposed by subtitle A of the IRC (for instance, PPP loan forgiveness excluded from gross income). On Nov. 18, 2020, Revenue Ruling 2020-27 and Revenue Procedure 2020-51 were issued, providing guidance on how this expense disallowance rule applies to taxpayers that had a reasonable expectation of PPP loan forgiveness as of the end of their 2020 taxable year.
The Consolidated Appropriations Act, 2021 was enacted on Dec. 27, 2020, and amended the CARES Act to provide that “no amount shall be included in the gross income of the eligible recipient by reason of forgiveness of indebtedness [on a PPP covered loan],” and “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of [that] exclusion from gross income.” As a result of this amendment, Treasury and the IRS released Revenue Ruling 2021-2 to obsolete Notice 2020-32 and Revenue Ruling 2020-27 as of the effective date of the amendment made to the CARES Act by the Consolidated Appropriations Act, 2021.
Though welcome, this guidance came too late for some fiscal year filers that did not claim deductions for otherwise deductible expenses on their return for the 2020 taxable year based on Notice 2020-32 and Revenue Ruling 2020-27. Revenue Procedure 2021-20 provides safe harbor relief in lieu of having to file an amended return or administrative adjustment request (AAR) to claim these deductions.