The Payroll Protection Program (PPP) was enacted as part of the Coronavirus Aid, Relief and Economic Security Act (CARES Act). Section 1106 of the CARES Act provides forgivable loans to eligible businesses if they retain their employees for the covered period, and the funds from the loans are used for payroll costs, health care benefits, interest on debts related to the business, rents and utility costs.
To the extent any of these costs are covered by a PPP loan, these expenses are not tax deductible if the loan is forgiven based on current IRS guidance. The CARES Act specifically states that the forgiveness of the debt is excluded from the business’ income. However, the IRS states that Section 265 denies a deduction for expenses attributable to tax-exempt income and that the forgiveness of the loan is the equivalent of tax-exempt income. Accordingly, the IRS’ position is that taxpayers that received PPP loans are not permitted to claim a tax deduction for expenditures related to the loan if the PPP loan is forgiven. (This is a controversial position that, in effect, diminishes or denies the benefit of the PPP program and may be challenged going forward.)
This raises the question of how to treat these expenses incurred in 2020 if the loan is still outstanding at the end of the year. Rev. Rul. 2020-27 states that the expenditures covered by the PPP are not deductible on the business’ 2020 tax return even where the business has not applied for or received forgiveness of the debt if there is a reasonable expectation that the loan will be forgiven. Rev. Proc. 2020-51 does provide that the expenses covered by the PPP loan are deductible if and when the forgiveness of the loan is denied or the taxpayer decides not to request forgiveness.