New IRS guidelines on canceled PPP loans: song remains the same
By our May 5, 2020 electronic alert, the IRS in Notice 2020-32 found that a taxpayer cannot deduct salaries, rent, utilities and other business expenses funded by a canceled Paycheck Protection Program (“P3”) loan. The IRS position has gone like a lead balloon with Congress, tax practitioners, and P3 loan recipients struggling to keep their businesses afloat, even in the face of ever-changing guidelines from the Small Business Association (“SBA On when and how they can get the loans canceled. Unfortunately, they won’t be happy with the IRS guidelines last week (Decision on revenues 2020-27 and Income procedure 2020-51) which, although the IRS brags about “clarifying,” actually cements the IRS’s ruthless position and only brings relief under unusual circumstances.
What the 2020-27 Revenue Decision Says
Our May 5, 2020 electronic alert discussed IRS Notice 2020-32 in detail and concluded that while the IRS position was bad for P3 loan recipients, it was not unexpected. In fact, the IRS was well-founded in its application of the relevant provisions of the Internal Revenue Code and case law and was in an untenable position anyway after Congress failed to determine whether the expenses funded by an canceled PPP loan were still deductible in the Coronavirus Aid, Relief and Economic Security Act (“CARES”), who created the PPP. Note that when the IRS issued Notice 2020-32, almost everyone expected that a taxpayer – especially a taxpayer using a calendar year, by 2020 – could get the PPP loan, pay the expenses. eligible and request and get remission all at the same time. year of declaration. Obviously, this expectation has faded because the Treasury, SBA, and banks are still working on the paperwork and procedures for PPP loan recipients who request forgiveness, and the minutiae about acts or omissions to do so. A PPP loan recipient could prevent the remission. (See our subsequent electronic alerts on May 8, June 8, again on June 8, and 21st of October, as well as our September 22 webinar on the ins and outs of loan forgiveness.)
Tax Decision 2020-27 takes this later reality into account and is addressed to two calendar year taxpayers, “A” and “B”, whose dazed and confused situations should now be familiar to any PPP loan recipient. Taxpayer “A” requests the rebate by the end of 2020 and meets all the conditions for the rebate. Taxpayer “B” will apply in 2021, but like “A”, he otherwise meets all the conditions for exemption. The 2020-27 Revenue Decision concludes that neither “A” nor “B” can deduct eligible expenses funded by PPP in 2020. The IRS continued to rely on the same laws and legal precedents as in the notice 2020-32, but with a slight twist. While the IRS in Notice 2020-32 analyzed a canceled PPP loan as the equivalent of an outright grant of tax-free money (such as a scholarship) assuming the PPP loan and cancellation occur. would produce in an integrated transaction in one year, the IRS in Tax Decision 2020-27 now analyzes the issue as whether “A” or “B”reasonably expected”The PPP loan to be canceled at the end of 2020. Even a PPP loan recipient who can somehow be sure that all the loan cancellation criteria have been met will be at best bewildered and at worst bewildered. banter at the IRS position that the recipient can somehow “reasonably expect” the loan to be canceled by the end of 2020, given the ever-changing landscape of the Treasury, the SBA and lenders and unexpected nuances that continue to appear. For PPP loan recipients, this has been the “direction” of the government’s battle for Evermore.
Tax Proceedings 2020-51 Give Some Relief, But Not Much
Income procedure 2020-51 offers advice to taxpayers like “A” and “B” above who reasonably believe they met the criteria for cancellation at the end of 2020, but whose loans are not in fact canceled in a subsequent year because the bank says “no” or the taxpayer decides, for whatever reason, not to request the rebate. The IRS gives the taxpayer three basic choices: (1) claim the deductions on his tax return for 2020 if it is filed on time (including any extensions); (2) claim the deductions on an amended tax return for 2020; or (3) claim the deductions in the income tax return for the following year in which it becomes clear that the loan will not be canceled. The 2020-51 Tax Procedure reviews the procedural requirements for this relief, including the notice form to be attached to the return so that the IRS understands that the taxpayer is relying on the 2020-51 Tax Procedure.
What to do?
Taxpayers not covered by the 2020-51 tax procedure – that is to say., PPP loan recipients who reasonably expect a forgiveness, have requested or intend to request a forgiveness by the end of 2020 and are successful in obtaining a forgiveness – continue to be in a difficult situation where they can’t deduct qualifying expenses (at least according to the IRS) in the current tax year if they get the PPP loan canceled in a subsequent tax year. Our May 5, 2020 electronic alertgave taxpayers two choices that still apply. The first choice, and the more conservative approach, is to file the return without claiming the deduction; hope for a congressional resolution or favorable court rulings; then request a refund from the IRS (keeping in mind the statute of limitations for requesting a refund and that the IRS has every interest in avoiding paying and forcing the taxpayer to go to court). The second choice, and the more aggressive approach, is to deduct expenses; develop a thoughtful argument as to why the IRS position is wrong; wait for an almost inevitable IRS exam; then challenge the IRS’s position in tax court without being required to pay the back taxes first. Note that if taxpayers opt for the second option, they must disclose in the declaration take a position contrary to a published IRS revenue ruling or face penalties (in addition to back taxes and interest).
Going to California – Compliance
From our May 5, 2020 electronic alert, the California legislature passed and Governor Newsom signed Assembly bill 1577, which takes the CARES Act position that a canceled PPP loan does not result in the forgiveness of debt income for California purposes. Unfortunately, AB 1577 also provides that the untaxed amount is to be offset and reduce otherwise deductible qualifying expenses, thus essentially adopting the IRS position. AB 1577 therefore puts California taxpayers in a bind because, even if Congress or a federal court overturns the IRS’s position, qualifying expenses remain non-deductible for California purposes, unless the California legislature no longer complies. late in the state’s treatment at the federal level.
So far, there is no “stairway to heaven” for PPP loan recipients. Stay tuned for updates on these issues, including the status of Congressional fixes that may still have life even after the November 3 election. For what it’s worth, Members of the senator’s finance committee on both sides of the aisle expressed dismay at the recent IRS guidelines and vowed to try a Congressional solution before the end of the year.