Certain 2020 PPP-Related Expenses Are Deductible in 2021; Amended Returns Not Required

(Parker Tax Publishing April 2021)

The IRS is providing a safe harbor for certain taxpayers that received a loan pursuant to the Paycheck Protection Program and, based on IRS guidance issued before the enactment of the COVID-related Tax Relief Act of 2020 in the Consolidated Appropriations Act, 2021, did not deduct certain otherwise deductible expenses paid or incurred during a tax year ending after March 26, 2020, and on or before December 31, 2020 (2020 tax year). Under the safe harbor, such taxpayers may elect to deduct these expenses on the taxpayer's timely filed original federal income tax return or information return, as applicable, for the taxpayer's first tax year following the taxpayer's 2020 tax year rather than filing an amended return or administrative adjustment request for the taxpayer's 2020 tax year. Rev. Proc. 2021-20.

Background

The Paycheck Protection Program (PPP) was established by Section 1102 and Section 1106 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in March of 2020. The PPP is overseen by the Small Business Administration (SBA). Under the PPP as it existed before the subsequent enactment of the Consolidated Appropriations Act, 2021 (the Appropriations Act) in December of 2020, the SBA was permitted to guarantee the full principal amount of a covered loan. Section 1102(a)(2) of the CARES Act defined a covered loan as a loan made under the PPP during the period beginning on February 15, 2020, and ending on December 31, 2020 (original PPP covered loan).

Before enactment of the Appropriations Act, the CARES Act provides that an individual or entity that was eligible to receive an original PPP covered loan (original eligible recipient) could receive forgiveness of the full principal amount of the loan up to an amount equal to the following costs incurred and payments made during the original PPP covered period: (1) payroll costs, (2) interest on a covered mortgage obligation, (3) any covered rent obligation payment, and (4) any covered utility payment (original eligible expenses). The CARES Act also provided that amounts that would otherwise be includible in the gross income of the eligible recipient by reason of forgiveness of PPP loan amounts were excluded from gross income. Such amounts were excludible regardless of whether the amount would be (1) income from the discharge of indebtedness under Code Sec. 61(a)(11), or (2) otherwise includible in gross income under Code Sec. 61.

In Notice 2020-32, the IRS clarified that no deduction was allowed for an otherwise deductible expense if the payment of the expense resulted in forgiveness of an original PPP covered loan. Subsequently, in Rev. Rul. 2020-27, the IRS ruled that a taxpayer that incurred otherwise deductible expenses in its 2020 tax year could not deduct those expenses if, at the end of the taxpayer's 2020 tax year, the taxpayer had a reasonable expectation of reimbursement of the expenses in the form of covered loan forgiveness. Additionally, in Rev. Proc. 2020-51, the IRS provided a safe harbor to address situations covered by Rev. Rul. 2020-27 when a taxpayer's expectation of covered loan forgiveness was not realized in a subsequent tax year.

COVID-Related Tax Relief Act

The COVID-related Tax Relief Act of 2020 (COVID Tax Relief Act) was enacted as part of the Appropriations Act. Section 276(a)(1) of the COVID Tax Relief Act amended Section 7A(i) of the Small Business Act to provide new rules regarding the federal income tax consequences of forgiveness of original PPP covered loans. Specifically, Section 7A(i) of the Small Business Act provides, in relevant part, that (1) no amount is includible in the gross income of an eligible PPP recipient by reason of forgiveness of indebtedness on an original PPP covered loan, and (2) no deduction will be denied, no tax attribute will be reduced, and no basis increase will be denied, by reason of that exclusion from gross income.

In January of 2021, the IRS issued Rev. Rul. 2021-2, which obsoleted Notice 2020-32 and Rev. Rul. 2020-27 due to the enactment of Section 276(a) of the COVID Tax Relief Act. Rev. Rul. 2021-2 provides that, as of December 27, 2020, the conclusion stated in Notice 2020-32 and the holding stated in Rev. Rul. 2020-27 are no longer accurate statements of the law. Likewise, the legal premise underlying Rev. Proc. 2020-51 is no longer accurate and, as of December 27, 2020, taxpayers could not have complied with the safe harbor requirements of Rev. Proc. 2020-51.

Rev. Proc. 2021-20 Safe Harbor Allows Deduction of 2020 Expenses in 2021

On April 22, the IRS issued Rev. Proc. 2021-20. Subject to certain limitations, Rev. Proc. 2021-20 allows a taxpayer to elect to deduct otherwise deductible original eligible expenses on the taxpayer's timely filed, including extensions, original federal income tax return or information return, as applicable, 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:

(1) is a "covered taxpayer"; and

(2) satisfies all of the requirements described in Rev. Proc. 2021-20.

A covered taxpayer is a taxpayer that satisfies all of the following:

(1) the taxpayer received an original PPP covered loan;

(2) the taxpayer paid or incurred original eligible expenses during the taxpayer's 2020 tax year;

(3) on or before December 27, 2020, the taxpayer timely filed, including extensions, a federal income tax return or information return, as applicable, for the taxpayer's 2020 tax year; and

(4) on the taxpayer's federal income tax return or information return, as applicable, the taxpayer did not deduct the original eligible expenses because (i) the expenses resulted in forgiveness of the original PPP covered loan; or (ii) the taxpayer reasonably expected at the end of the 2020 tax year that the expenses would result in such forgiveness.

Expenses Not Covered by Rev. Proc. 2021-20

Section 304(b)(2) of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act), which was also enacted as part of the Appropriations Act, expanded the list of expenses for which an individual or entity that received an original PPP covered loan could receive forgiveness. However, because those 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 applying the safe harbor provided by Rev. Proc. 2021-20. Those expenses include:

(1) payments for covered operations expenditures, which are payments for any business software or cloud computing service that facilitates business operations, product or service delivery, the processing, payment or tracking of payroll expenses, human resources, sales and billing functions, or accounting or tracking of supplies, inventory, records and expenses;

(2) payments for covered property damage costs, which are costs related to property damage and vandalism or looting due to public disturbances that occurred during 2020 that was not covered by insurance or other compensation;

(3) payments for covered supplier costs, which means expenditures made by an entity to a supplier of goods for the supply of goods that (i) are essential to the operations of the entity at the time at which the expenditure is made; and (ii) are made pursuant to a contract, order, or purchase order in effect at any time before the covered period with respect to the applicable covered loan; or with respect to perishable goods, in effect before or at any time during the covered period with respect to the applicable covered loan; and

(4) payments for covered worker protection expenditures, which are payments for an operating or a capital expenditure to facilitate the adaptation of the business activities of an entity to comply with requirements established or guidance issued by the Department of Health and Human Services, the Centers for Disease Control, or the Occupational Safety and Health Administration, or any equivalent requirements established or guidance issued by a state or local government, during the period beginning on March 1, 2020, and ending on the date on which the national emergency declared by the President under the National Emergencies Act with respect to the Coronavirus Disease 2019 (COVID-19) expires related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19.

Compliance Tip: A covered taxpayer must make the election to apply the safe harbor by attaching a statement to a timely filed, including extensions, federal income tax return or information return, as applicable, 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. To make a valid election to apply this safe harbor, a covered taxpayer must (i) attach a statement, titled "Revenue Procedure 2021-20 Statement" (and named RevProc2021-20.pdf for e-file attachments), with the covered taxpayer's name, address, and social security number or taxpayer identification; (ii) a statement that the covered taxpayer is applying the safe harbor provided by Sec. 3.01 of Rev. Proc. 2021-20; (iii) the amount and date of disbursement of the taxpayer's original PPP covered loan; and (iv) 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, as applicable, for the covered taxpayer's first tax year following that 2020 tax year.

Rev. Proc. 2021-20 does not preclude the IRS from examining any issues relating to the claimed deductions for original eligible expenses, including determining whether a taxpayer is a covered taxpayer, the amount of the deduction, and whether the covered taxpayer has substantiated the deduction claim. Nor is the IRS precluded from requesting additional information or documentation verifying any amounts described in the statement required by Rev. Proc. 2021-20.

For a discussion of the rules relating to PPP discharge of indebtedness, see Parker Tax ¶72,340.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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