Safe harbor allows deduction of PPP expenses retroactively

| 4/29/2021
Safe harbor allows deduction of PPP expenses retroactively

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.

Background

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.

Sign up to receive the latest tax insights as well as tax regulatory and administrative updates.

Safe harbor

Under the safe harbor, a taxpayer may elect to deduct eligible expenses on its timely filed federal income tax return or information return (including extensions) for the immediately subsequent taxable year, rather than file an amended return or AAR for its 2020 taxable year in which the expenses were paid or incurred. This provides eligible taxpayers flexibility to choose which tax year to deduct such eligible expenses, based on their ability or appetite to amend a previously filed tax return.

A taxpayer satisfying all of the following is eligible for the safe harbor:

  1. The taxpayer received a PPP covered loan (a first-draw loan with a disbursement date in 2020).
  2. The taxpayer paid or incurred eligible expenses (based on 2020 rules) related to the PPP covered loan during the taxpayer’s 2020 taxable year.
  3. On or before Dec. 27, 2020, the taxpayer timely filed a federal income tax return or information return (including extensions) for its 2020 taxable year.
  4. On the taxpayer’s federal income tax return or information return for the 2020 taxable year, the taxpayer did not deduct the eligible expenses because the expenses resulted in forgiveness of the PPP covered loan or the taxpayer reasonably expected at the end of the 2020 taxable year that the expenses would result in such forgiveness.

The safe harbor election is made by attaching to the tax return a statement containing the required information listed in Revenue Procedure 2021-20 for the first taxable year following the taxpayer’s 2020 taxable year in which the eligible expenses were paid or incurred.

Looking ahead

Some fiscal year-end taxpayers might have filed their returns without deducting the eligible expenses based on the guidance in effect at the time their return was filed. If elected, the safe harbor provides a streamlined process to deduct those expenses in the following tax year. Taxpayers should evaluate their options to determine the best course to take.

Related topics

Stay up to speed on regulatory and legislative tax changes with timely updates from Crowe.

Our leaders offer insights into tax changes the Biden administration might pursue.

Stay up to speed on regulatory and legislative tax changes with timely updates from Crowe.

Our leaders offer insights into tax changes the Biden administration might pursue.

Contact us

Our experienced tax professionals can help you tackle your most pressing tax challenges. Contact the Crowe tax team today.
Veena Murthy
Veena Murthy
Principal, Washington National Tax
David Strong
David Strong
Partner