Late last week, the IRS and Treasury issued both a revenue ruling and a revenue procedure, doubling down on their stance that since businesses aren’t taxed on the proceeds of a forgiven PPP loan, the expenses aren’t deductible.

This isn’t new news, of course. The IRS is bound to statute on this one and doesn’t have any wiggle room — only Congress can legislate on the topic of what is taxable and deductible, whereas the IRS only has administrative oversight in this arena. They made it clear very early in the game — April 30th, in fact — that they had no intention of accepting deductions for expenses that were paid for with PPP funds.

But in the ensuing months, Congress — despite broad bipartisan support for a measure to render these costs deductible — has been stuck in gridlock and failed to pass legislation making it so. This recent action on the part of the IRS seems designed to signal Congress that only by their action will the original intent of the CARES Act be realized.

However, the IRS took this particular set of guidance one unfortunate step further, at least as far as my clients are concerned.

“If a business reasonably believes that a PPP loan will be forgiven in the future, expenses related to the loan are not deductible, whether the business has filed for forgiveness or not.”

Now, I have been attending the AICPA Town Halls since nearly the beginning of the pandemic, and they are still strongly recommending that no one apply for forgiveness before year-end unless:
1) they need to sell their business;
2) loan covenants are at risk; or,
3) they need to reduce FTEs after meeting a date-driven safe harbor.

Part of the reason for this suggested delay is the aforementioned statutory requirement that prohibits the IRS from permitting any deductions for expenses paid for with non-taxable income. (Also: likeliness of legislation authorizing automatic forgiveness under a certain threshold; and the need for further guidance in many areas that remain unanswered.)

The idea was that if forgiveness was not granted in 2020, then the deductions could be made as usual on tax returns filed in the first-half of 2021. When forgiveness was eventually granted on these PPP loans, one of two things would have happened:
1) Congress would since have acted to protect the deductions and therefore PPP funds could be accepted into non-taxable income; or,
2) Congress would not have acted, in which case the PPP income would effectively be made taxable in 2021.

For the record, it wasn’t just me making this assumption. The entire American Institute of Certified Public Accountants thought the same thing (and in fact are now asking their members to contact elected officials to push for it). As did my most revered and favorite tax writer, Tony Nitti, who spent an entire article describing how wrong he was.

To me, whether the expenses paid with PPP proceeds were deductible hinged on whether forgiveness was obtained; as a result, I strongly maintained that those expenses did NOT become nondeductible until that “condition subsequent” occurred. As a result, if a business were filing its 2020 tax return before word on its forgiveness application had come down from the SBA, the expenses would be fully deductible. After all, we have a little something called the “tax benefit” rule, which allows a taxpayer a full deduction if at the time of filing the return, no event has occurred to render the amount nondeductible. Then, if a future event occurs that is fundamentally inconsistent with the premise on which the previous deduction was based (for example, an unforeseen refund of deducted expenses, or in this case, the forgiveness of a loan), the taxpayer must take the deducted amount into income. Applying the principles of Section 111 to PPP loans, the taxpayer would be entitled to a full deduction in 2020, with a potential income pick-up in 2021 when the loan was forgiven.

But with this recent IRS guidance, as Tony points out — he was wrong (again).

According to the Ruling, it matters not whether the application for forgiveness has been filed by the time the tax return is ready to go; rather, what matters is that the taxpayer apparently knows, in their heart of hearts, that the loan will ultimately be forgiven. After all, as the Ruling explains, “Section 1106(b), (d), and (g) of the CARES Act, and the supporting loan forgiveness application procedures published by the SBA, provide covered loan recipients… with clear and readily accessible guidance to apply for and receive covered loan forgiveness,” a sentence which I would have found laughable had the lies contained within it not ruined the past six months of my life.

I won’t get into the details of what it means to “reasonably expect” forgiveness, or determine partial forgiveness, or whether or not the new safe harbor applies if you “reasonably expect” wrong. (I’ll let Alan Gassman, another fan of Tony’s, dive into those weeds.) But as a short summary:
1) You can deduct expenses on your 2020 return if you find out before the return is filed that the PPP loan didn’t get forgiven or if you decide not to apply for forgiveness;
2) If you guessed wrong about the amount of forgiveness (and therefore deductions), you can either a) amend the 2020 return to adjust the disallowance, or b) deduct the improperly disallowed expenses for 2020 in the year forgiveness is determined.

Somehow, with not only a revenue procedure but also a revenue ruling, the IRS managed not to address two big issues that their rulings raise:
1) How should a Schedule C filer handle the deduction question? For a self-employed person, it’s not the expenses that determine forgiveness, but rather a calculation based on their 2019 income.
2) Which deductions will be limited, and in what order (payroll, rent, mortgage interest, utilities)? This has serious ramifications for the §199A Qualified Business Income deduction, Research & Development credits, and the §163(j) Interest Deduction limitation.

But I am not even going to touch on those two issues. Why? Because I truly believe the IRS made this announcement to rile up Congress members into finally taking action. It might have worked.

As reported in Accounting Today:

The leaders of the Senate Finance Committee, chairman Chuck Grassley, R-Iowa, who is now battling a coronavirus infection, and ranking member Ron Wyden, D-Oregon, blasted the guidance issued by the Treasury. “Since the CARES Act, we’ve stressed that our intent was for small businesses receiving Paycheck Protection Program loans to receive the benefit of their deductions for ordinary and necessary business expenses,” they said in a joint statement Thursday. “We explicitly included language in the CARES Act to ensure that PPP loan recipients whose loans are forgiven are not required to treat the loan proceeds as taxable income. As we’ve stated previously, Treasury’s approach in Notice 2020-32 effectively renders that provision meaningless. Regrettably, Treasury has now doubled down on its position in new guidance that increases the tax burden on small businesses by accelerating their tax liability, all at a time when many businesses continue to struggle and some are again beginning to close. Small businesses need help maintaining their cash flow, not more strains on it.”

Grassley and Wyden said they would continue their efforts to clarify in any end-of-year legislation the intended relief in the CARES Act to help small businesses at this critical time. “We encourage Treasury to reconsider its position on the deductibility of these expenses, and the timing of those deductions, to provide relief to the small businesses that need it most,” they added.

In the meantime… as an accountant, what do you tell your clients? As a small business owner, what do you do?

Well, if I’m right, and Congress is duly riled, then hopefully we’ll finally see some movement here, preferably before the end of the year, but (dear lord please) at least before tax season. At which point — poof — it becomes a non-issue (with the exception of the countless hours I and others have spent worrying and writing about it).

And if not?

I’ll share the recommendations of one of the most worthwhile practitioner-guests the AICPA has had on their Town Hall yet, Bill Pirolli (Partner, DiSanto Priest & Co.):

Tax Filing Approaches for Consideration
1) Wait and see
• Use extensions until additional guidance or legislation is available
• Pass-through entities don’t need to be concerned until March/April 2021 deadlines
2) File return and pay taxes
• Assumes expenses paid with PPP funds will not be tax deductible
• If this changes, the borrower can file an amended return
3) File return and deduct expenses**
• Contrary to current guidance (but in the spirit of the PPP legislation)

**(CPA Academy is offering a course on how to launch a challenge to the IRS on this topic — and penalty-proof it — this Wed 11/25 and Mon 11/30.)

For what it’s worth, Bill describes himself as a “wait and see” kind of guy.
(I strongly suggest watching Bill’s participation in the most recent AICPA Town Hall — from 32:00 through 52:40. His logical process, description of history and legislative intent, and arguments are thought-provoking.)

I’ve already spoken with my tax partner, and our plan is to put all partnership and corporate clients on extension to avoid the unnecessary cost of approach #2 and the unnecessary risk of approach #3. Haven’t yet decided how to handle Schedule C self-employed filers… but also hoping we won’t have to cross that bridge.

In the meantime, it’s business as usual, trying to close out books and prepare for 1099s… as if it were any other pandemic year-end.

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