IRS Confirms Deductibility of Expenses Paid with PPP Funds, Revokes Previous Guidance

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) introduced the Paycheck Protection Program (PPP) to grant loans to small businesses, nonprofit organizations, veterans’ organizations and tribal businesses in an effort to address the financial crisis and keep workers employed during the COVID-19 pandemic. A PPP loan recipient may use the funds to pay for several types of expenses, including payroll costs, certain employee healthcare costs, interest on mortgage obligations, rent, operational expenditures, and covered worker protection equipment. Subject to certain requirements, a borrower can apply to the lender for all or a portion of the PPP loan to be forgiven.

Section 1106(i) of the CARES Act specifically provides that any amount of PPP loan forgiveness that would otherwise be includible in gross income by reason of forgiveness is instead excluded from gross income. However, the CARES Act, as originally enacted, was silent as to whether eligible business expenses that result in PPP loan forgiveness would be deductible for tax purposes. In response to this uncertainty, the IRS and Treasury issued Notice 2020-32 and Rev. Rul. 2020-27, both of which concluded that a borrower would not be allowed to deduct expenses paid or incurred that result in the forgiveness of a covered PPP loan if the income associated with the forgiveness is ultimately excluded from gross income.

The COVID-related Tax Relief Act of 2020 amended the CARES Act to clarify that no deduction is denied, no tax attribute is reduced and no basis increase is denied by reason of the exclusion from gross income of the forgiveness of an eligible recipient’s covered loan. This change is applicable for taxable years ending after March 27, 2020. Accordingly, taxpayers that incur or pay PPP-eligible expenses may deduct the amounts in the year paid or incurred, and take into account the full amount of such expenses in computing any related tax attributes, such as the R&D tax credit and the Work Opportunity Tax credit.

As a result of the amendment made by the Tax Relief Act of 2020, the IRS and Treasury issued Rev. Rul. 2021-2 to declare Notice 2020-32 and Rev. Rul. 2020-27 obsolete as of the effective date of the amendment. As such, taxpayers seeking to deduct PPP-eligible expenses on their returns should no longer expect challenges from the IRS upon examination with respect to this particular issue. Further, any taxpayers that may have already filed tax returns disallowing the expenses should consider amending such returns to claim the additional deductions prior to the statute of limitations expiration date.