Expenses paid with 2020 PPP loans can be deducted on 2021 tax returns

The IRS announced a safe harbor for certain businesses that received first-round Paycheck Protection Program (PPP) loans but did not deduct any of the original eligible expenses because they relied on guidance issued before the enactment of the Consolidated Appropriations Act, 2021 (CAA), P.L. 116-260, in December 2020.

In Notice 2020-32 and Rev. Rul. 2020-27 (which were obsoleted by Rev. Rul. 2021-2) the IRS provided that a taxpayer that received a loan through the PPP was not permitted to deduct expenses that are normally deductible under the Code to the extent the payment of those expenses resulted in PPP loan forgiveness. In reliance on that guidance, many taxpayers did not deduct expenses paid with PPP loan proceeds on their 2020 tax returns. Congress later clarified in the CAA that deductions are allowed for otherwise deductible expenses paid with the proceeds of a PPP loan that is forgiven and that the tax basis and other attributes of the borrower’s assets will not be reduced as a result of the loan forgiveness.

The new safe harbor in Rev. Proc. 2021-20 allows taxpayers who filed a tax year 2020 return on or before Dec. 27, 2020, to deduct those expenses on their 2021 tax return rather than file amended returns or administrative adjustment requests.

Under the safe harbor, subject to limitations permitting the IRS to examine those expenses on audit or request additional information or documentation, a taxpayer may elect to deduct otherwise deductible original eligible expenses on the taxpayer’s timely filed, including extensions, original federal income tax return or information return for the taxpayer’s immediately subsequent tax year, rather than on an amended return or administrative adjustment request for the taxpayer’s 2020 tax year in which the expenses were paid or incurred, if the taxpayer:

• Is a “covered taxpayer,” as defined below; and
• Satisfies all of the requirements for the time and manner of making the election to apply the safe harbor.

A covered taxpayer must satisfy all the following requirements:

• The taxpayer received an original PPP covered loan;
• The taxpayer paid or incurred original eligible expenses during the taxpayer’s 2020 tax year;
• On or before Dec. 27, 2020, the taxpayer timely filed, including extensions, a federal income tax return or information return for the taxpayer’s 2020 tax year; and
• On the taxpayer’s federal income tax return or information return, the taxpayer did not deduct the original eligible expenses because: (1) The expenses resulted in forgiveness of the original PPP covered loan; or (2) the taxpayer reasonably expected at the end of the 2020 tax year that the expenses would result in that forgiveness.

Exclusions

Rev. Proc. 2021-20 does not apply to expenses in the expanded list of expenses in Section 304(b)(2) of Division N, Title III, of the CAA, for which an individual or entity that received an original PPP covered loan could receive forgiveness. Because those new expenses were not included as part of the original eligible expenses, those expenses are not eligible to be deducted through an election by a covered taxpayer to apply the safe harbor in the revenue procedure.

In addition, the safe harbor does not apply to PPP second-draw loans enacted under the CAA. Because PPP second-draw loans are not original PPP covered loans, eligible expenses that may result in forgiveness of those loans are not covered by Rev. Proc. 2021-20.

Time and manner to make election

To make a valid election to apply the safe harbor, a covered taxpayer must attach the statement described below to the covered taxpayer’s timely filed, including extensions, federal income tax return or information return for the covered taxpayer’s first tax year following the covered taxpayer’s 2020 tax year in which the original eligible expenses were paid or incurred.

The statement must be titled “Revenue Procedure 2021-20 Statement” (and named RevProc2021-20.pdf for e-file attachments) and include the following:

• The covered taxpayer’s name, address, and Social Security number or taxpayer identification number;
• A statement that the covered taxpayer is applying the safe harbor in Rev. Proc. 2021-20;
• The amount and date of disbursement of the taxpayer’s original PPP covered loan; and
• A list, including descriptions and amounts, of the original eligible expenses paid or incurred by the covered taxpayer during the covered taxpayer’s 2020 tax year that are reported on the federal income tax return or information return for the first tax year following the 2020 tax year.

The revenue procedure is effective for any tax year ending in calendar year 2020 and for the immediately subsequent tax year.

— Sally P. Schreiber, J.D., (Sally.Schreiber@aicpa-cima.com) is a JofA senior editor.