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IRS allows certain fiscal-year taxpayers to deduct previously disallowed PPP expenses without amending returns

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May 2021

In brief

The IRS recently issued Rev. Proc. 2021-20, providing a safe harbor benefiting fiscal-year taxpayers that paid or incurred certain business expenses covered by a Paycheck Protection Program (PPP) loan and did not deduct the expenses under IRS administrative guidance that subsequently was overturned by the Consolidated Appropriations Act, 2021 (Appropriations Act).

The safe harbor allows a ‘covered taxpayer’ to deduct the expenses on the taxpayer’s federal income tax return (or information return) for the first tax year following the tax year in which the expenses were paid or incurred instead of filing an amended return (or administrative adjustment request). The safe harbor applies to taxpayers that paid or incurred the expenses during a tax year ending after March 26, 2020, and on or before December 31, 2020, and timely filed (including extensions) a return for that tax year on or before December 27, 2020.

Action item:  Affected taxpayers should consider whether the administrative convenience of the safe harbor outweighs filing an amended return and receiving the immediate benefit of the deduction.

In detail

Background

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), enacted on March 27, 2020, created the PPP to provide loans through the Small Business Administration to certain taxpayers experiencing economic hardship as a result of the COVID-19 pandemic. PPP loans may be used for eligible expenses such as payroll, mortgage interest, rent, or utilities (eligible expenses) and may be forgiven if certain requirements are met. Forgiven loan amounts that otherwise would be taxable as discharge of indebtedness income may be excluded from gross income. 

The IRS subsequently issued administrative guidance addressing the tax treatment of eligible expenses, which provided that a taxpayer:

  • may not deduct eligible expenses if the PPP loan was forgiven and the amount was excluded from income;
  • may not deduct eligible expenses paid or incurred in a tax year if, at the end of the tax year, the taxpayer reasonably expected the loan to be forgiven; and
  • may deduct eligible expenses under certain conditions in a tax year after the taxpayer reasonably expected the loan to be forgiven when the application for forgiveness is denied or the taxpayer decides not to apply for forgiveness. 

The Appropriations Act, enacted on December 27, 2020, prohibits denying a deduction, reducing a tax attribute, or denying a basis increase by reason of the exclusion from gross income, effective retroactively to the date of enactment of the CARES Act. In response to this new legislation, the IRS issued Rev. Proc. 2021-20, providing a safe harbor to help affected taxpayers and noting that the statements in its prior administrative guidance “are no longer accurate statements of the law.”

What does the safe harbor allow taxpayers to do? 

The safe harbor outlined in Rev. Proc. 2021-20 allows a covered taxpayer to avoid filing an amended return by electing to deduct eligible expenses paid or incurred during the original PPP covered period (original eligible expenses) on its return for the first tax year following the tax year in which those expenses were paid or incurred if it follows certain procedural requirements. 

Who is a covered taxpayer?

A taxpayer is a covered taxpayer eligible for the safe harbor if the taxpayer (1) received a PPP loan during the period beginning on February 15, 2020, and ending on December 31, 2020 (original PPP covered loan); (2) paid or incurred original eligible expenses during a tax year ending after March 26, 2020, and on or before December 31, 2020; (3) timely filed (including extensions) a return for that tax year on or before December 27, 2020; and (4) did not deduct the original eligible expenses because (a) the original PPP covered loan was forgiven, or (b) the taxpayer had a reasonable expectation at the end of the tax year that the loan would be forgiven.

Observation: The safe harbor benefits a fiscal-year taxpayer with a tax year ending within the specified period that filed its return for that tax year on or before December 27, 2020. A calendar-year taxpayer has less of a need for a similar safe harbor because it has an opportunity to deduct its original eligible expenses on its original return filed in 2021. 

How does a taxpayer elect the safe harbor?

A taxpayer elects the safe harbor by attaching a statement to its timely filed return for the first tax year following the tax year in which the taxpayer paid or incurred the original eligible expenses. The statement must be titled ‘Revenue Procedure 2021-20 Statement’ (and named ‘RevProc2021-20.pdf’ for e-file attachments) and include the following information:

  • the taxpayer’s name, address, and social security number or taxpayer identification number;
  • a statement that the taxpayer is applying the safe harbor;
  • 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 that are being reported on the return for the taxpayer’s first subsequent tax year. 

Rev. Proc. 2021-20 states that electing the safe harbor does not preclude the IRS from examining issues relating to the deductions for original eligible expenses or requesting additional information or documentation to verify the amounts included with the required statement. 

The takeaway

The safe harbor in Rev. Proc. 2021-20 provides flexibility to fiscal-year taxpayers that did not deduct original eligible expenses under prior IRS administrative guidance by providing a process to deduct the expenses without filing an amended return. Taxpayers wishing to elect the safe harbor should ensure that they meet all eligibility and procedural requirements.

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Shari Forman

Private Tax Leader, PwC US

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