Taxation of PPP Loan Forgiveness

In early 2020, many of you took advantage of the Paycheck Protection Program (PPP) that the Coronavirus Aid, Relief and Economic Security (CARES) Act created. As we approach the end of 2020, one very important item to keep in mind are implications of the PPP loan that you may have received.

When the U.S. Congress passed the CARES Act, the Act provided that the loan amount forgiven was to be excluded from taxable income. Generally, when a debt is cancelled, IRS code requires that the amount of the debt that is cancelled is treated as taxable income unless excluded by a specific tax code. Although the CARES Act noted that the amount of PPP loan that is forgiven is not taxable income, it did not address whether the expenses paid using the PPP loan funds is deductible to extent of the loan that is eventually forgiven.

Recently, under Internal Revenue Code Section 265(a)(1), the IRS has clarified that no deduction will be allowed for amounts paid using PPP loan funds that are eventually forgiven. The effect of this is that the amount of the PPP loan that is forgiven increases your taxable income by the amount forgiven and the offsetting expenses are not deductible. While there could be future legislation that changes this ruling, the rules as they stand today provide for no deductions for expenses paid for using PPP loan funds that is eventually forgiven.

An important nuance to this is contained in IRS Revenue Ruling 2020-27, which provided that eligible expenses paid for using the PPP loan funds are not deductible in the year paid if at the end of that year the taxpayer reasonably expects to eventually receive loan forgiveness. To the extent that a taxpayer reasonably expects that the PPP loan will not be forgiven, items paid with the proceeds of the non-forgiven PPP loan are deductible. In this ruling the IRS provided two examples in which the taxpayer received PPP loans and used the loan proceeds for qualifying expenses in 2020. In first example, the taxpayer applied for loan forgiveness in November of 2020 but had not been informed by the lender by the end of 2020 whether the loan was forgiven. In the second example, the taxpayer had not applied for the loan forgiveness by the end of 2020 but knew the amount of expenses that qualified for the forgiveness. Because the taxpayers under both the examples reasonably expected for the PPP loan to be forgiven, no deductions for the expense would be allowed.

In November 2020, the IRS also issued Revenue Procedure 2020-51, which provide safe-harbor rules allowing a taxpayer to claim a deduction for eligible expenses that the taxpayer paid for or incurred in 2020 for which no deduction is permitted because the taxpayer reasonably expected to apply for and receive PPP loan forgiveness. The safe-harbor rules apply under the following two situations –

  • The taxpayer submitted before the end of 2020 or intends to submit in a subsequent year an application for loan forgiveness and in the subsequent taxable year, the lender notifies the taxpayer that forgiveness of all or part of the covered loan is denied.
  • The taxpayer pays for and reasonably expects to receive loan forgiveness but subsequently decides to not seek forgiveness for some or all of the covered loan.

In these situations, the taxpayer can deduct the qualifying expenses on a 1) timely filed 2020 original tax return by the extended due date (if the lender notifies the taxpayer of the denial of all or part of the covered loan before the original 2020 tax return is filed); 2) on an amended 2020 tax return; or 3) on a timely filed tax return for a subsequent year (2021). The revenue procedure also requires the taxpayer to include various information related to the PPP loan and the amounts of the eligible and non-deductible eligible expenses that are reported on the tax return.

Finally, companies that have received a PPP loan will have book financial reporting issues to consider. The American Institute of Certified Public Accountants (AICPA) has provided guidance that the PPP loans can be accounted for as either a loan under generally accepted accounting principles or as a grant under rules governing not for profit entities.

As a loan, interest should be accrued using the rate included in the CARES Act (1%) and the PPP advance should continue to be recorded as a loan until it is formally forgiven in writing. At the time of formal forgiveness a gain is recorded which includes the accrued interest.

Accounting for the PPP as a grant requires the reporting entity to reasonably believe that the loan will be forgiven. In this case, the amount should be reported as deferred income on the balance sheet and reflected on the income statement over time as expenses allowable for the forgiveness calculation are incurred.

Please contact HKP for assistance or more details on the financial statement accounting for PPP loans.

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