Expenses with PPP loans can be written off

The Paycheck Protection Program was the centerpiece of the CARES Act, providing loans to businesses of up to $10 million. If you comply, you don't even have to pay your loan back. What's more, there is not even any forgiveness of debt income when your loan is forgiven, something that normally is a standard tax result from a forgiven loan. So far, so good, but can businesses claim tax deductions for business expenses?

That sounds like a silly question, of course business expenses are deductible. But can you deduct them if you use forgiven PPP loan money to pay for them? Until now, the debate has raged, with the IRS saying multiple times "no way, no tax deduction." But finally, Congress has come to the rescue. Congress has said that the whole point of the program was to provide needed loan money for wages and other key expenses.

The loan forgiveness was key too, and the law says that despite normal tax rules, if the loan is forgiven, that will not be income. Remember, normally, if a loan is forgiven, the forgiven amount is taxable income. The PPP is an exception. Now that the third piece of the puzzle is finally in place, you can still claim normal tax deductions for business expenses paid with PPP money.

The latest COVID relief law states expressly that "no deduction shall be denied or reduced, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income provided by [the loan forgiveness provision that says forgiven PPP loans will not count as income]."

There has been uniform agreement from business that allowing tax deductions should be the rule, which is hardly surprising. But the IRS position has been unmovable. From the beginning, the IRS relied on what it said were traditional tax principles. The IRS has said again and again that it would be an impermissible double tax benefit to have income on debt forgiveness not taxed as income, and then to also allow tax deductions for the expenses paid with the forgiven loan money.

The debate rages in professional circles too. Some tax lawyers and academics sided with the IRS in this debate. In fact, some groups and news sources have objected strongly to allowing the tax deductions, even saying that a change to allow the tax deductions would be a $100 billion tax deduction to the wealthy, or a $120 billion windfall to the top 1%. Now that the Congress had the last word on this long debated and highly controversial topic, it is not clear whether all the talk will stop.

Businesses that snapped up the PPP loan money and that spent the money on wages and rent have been wringing their hands as the 2020 tax year comes to a close. Some of the history is worth nothing. The most recent IRS Notice was 2020-32. There, the IRS made clear that the timing of the loan, the expenses, and the loan forgiveness would not matter. The IRS said it would deny tax deductions even for expenses that are normally fully deductible.

Although Congress has finally said expenses can be deducted, it was sure a long time in coming. Shortly after the CARES Act was passed early this year and flaps over PPP tax deductions started brewing, Congress quickly moved to reverse the IRS in the Small Business Expense Protection Act, S.3612, 116th Congress (2019-2020). That bill languished, caught up in endless political wrangling about various forms of stimulus relief.

In the meantime, the IRS has kept saying now in various administrative announcements. For example, the IRS released Revenue Ruling 2020-27 to address situations where a loan is not yet forgiven but might be in the future. In the ruling, the IRS described two situations. In the first, a borrower pays payroll and mortgage interest that are valid PPP expenditures. The borrower applies for forgiveness in November 2020 and satisfied all the requirements under the CARES Act to have it forgiven, but it doesn't yet have an answer as to whether it will be forgiven.

In the second case, the borrower paid the same type of expenses with its PPP loan, but expects to apply for forgiveness in 2021. In both cases, the IRS says the business cannot deduct these business expenses. The businesses both have a "reasonable expectation" that the loans will be forgiven. The IRS also released Rev. Proc. 2020-51, which provides a safe harbor for PPP borrowers whose loan forgiveness has been partially or fully denied and who wish to claim deductions for otherwise eligible payments on a return, amended return, or administrative adjustment request.

All the IRS releases are out the window now. You can deduct your business expenses as usual, regardless of whether PPP money is used for them, and regardless of whether your PPP loan is forgiven. There is still likely to be a bit of a scramble among taxpayers with PPP loans. Although they should all be breathing a sigh of relief, many of them have been fence-sitting for a while.

For example, they may be trying to determine their taxable income for 2020, what cash -- if any -- they can distribute to the owners of the business, and whether they need to make estimated tax payments right away. They may have been waiting to make a loan forgiveness application for their PPP loan too. Now, in the mix, will be considerations about an additional round of PPP funding. The new coronavirus relief bill provides for additional PPP loans in some cases. For the hotly debated tax deduction question, though, Congress has had the last word, and it is one in the taxpayer's favor. 