The IRS has provided relief for some taxpayers who filed returns for tax years ending on or after March 26, 2020 and on or before December 31, 2020 who did not deduct expenses paid with PPP loan proceeds in Revenue Procedure 2021-20.[1]  Those taxpayers may now worry that they will have to amend their already filed tax returns or face the loss of a deduction for those expenses that were retroactively allowed as a deduction by the COVID-related Tax Relief Act that was enacted on December 27, 2020.

Original IRS Guidance Denying the Deduction and Congressional Action to Overturn IRS Rulings

Former Treasury Secretary Mnuchin famously announced in a television interview that it was “Tax 101” that taxpayers who did not recognize forgiveness of their PPP loans as income due to paying certain expenses could not claim a deduction for those expenses.  The IRS issued guidance backing up that position during 2020.

As the Procedure explains:

On April 30, 2020, the Treasury Department and the IRS released Notice 2020-32, 2020-21 IRB 837 (May 18, 2020), which clarified that no deduction was allowed for an otherwise deductible expense if the payment of the expense resulted in forgiveness of an original PPP covered loan. On November 18, 2020, the Treasury Department and the IRS released Rev. Rul. 2020-27, 2020-50 IRB 1552 (December 7, 2020), which held that a taxpayer that incurred otherwise deductible expenses in its 2020 taxable year could not deduct those expenses if, at the end of the taxpayer’s 2020 taxable year, the taxpayer had a reasonable expectation of reimbursement of the expenses in the form of covered loan forgiveness. Also on November 18, 2020, the Treasury Department and the IRS released Rev. Proc. 2020-51, 2020-50 IRB 1599 (December 7, 2020), which provided a safe harbor to address situations covered by Rev. Rul. 2020-27 when the taxpayer’s expectation of covered loan forgiveness was not realized in a subsequent taxable year.[2]

As well known as the former Secretary’s position was, it was also well known that three of the four ranking members of the tax committees had penned a letter strenuously disagreeing with that position, and they committed to passing legislation to overturn that result.

While it took a while, in December the change became law as part of the COVID-related Tax Relief Act.  The Notice continues:

On December 27, 2020, the Appropriations Act was enacted. Section 304(b)(1)(A) of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act), which was enacted as Title III of Division N of the Appropriations Act, redesignated § 1106 of the CARES Act as § 7A of the Small Business Act, transferred the section to the Small Business Act (15 U.S.C. § 631 et seq.), and inserted that section so as to appear after § 7 of the Small Business Act (15 U.S.C. § 636)). Section 276(a)(1) of the COVID-related Tax Relief Act amended § 7A(i) of the Small Business Act to provide new rules regarding the Federal income tax consequences of forgiveness of original PPP covered loans. Specifically, § 7A(i) of the Small Business Act provides, in relevant part, that “no amount shall be included in the gross income of the eligible recipient by reason of forgiveness of indebtedness [on an original PPP covered loan],” and “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of [that] exclusion from gross income.”[3]

In late January 2021, the IRS followed up with a ruling formally taking back the prior guidance:

Rev. Rul. 2021-2, 2021-4 IRB 495 (Jan. 25, 2021), which was released on January 6, 2021, obsoleted Notice 2020-32 and Rev. Rul. 2020-27 due to the enactment of § 276(a) of the COVID-related Tax Relief Act. Rev. Rul. 2021-2 provides that, as of December 27, 2020, the conclusion stated in Notice 2020-32 and the holding stated in Rev. Rul. 2020-27 are no longer accurate statements of the law. Likewise, the legal premise underlying Rev. Proc. 2020-51 is no longer accurate and, as of December 27, 2020, taxpayers could not have complied with the requirements of section 3.01 or 3.02 of Rev. Proc. 2020-51.[4]

What if a Taxpayer Filed a Return Based on the IRS Guidance?

Of course, during this time fiscal years ended and taxpayers planned for calendar year 2020 returns based on the IRS guidance that indicated they would not obtain a deduction for such expenses.  Taxpayers who filed a return that followed the IRS guidance either because it was in effect when they filed their return (say for fiscal year C corporations with year ends from March to November) or because they weren’t aware of the change in the law and IRS revocation of the earlier rulings when they prepared their return now seemed to be required to go back and amend those prior returns.

As a general rule, a deduction must be claimed in the year in which the tax law provides for it to be claimed—a taxpayer can’t “bank” deductions and then take them in a later year.  Thus, if these taxpayers did not go back and amend those prior returns, they faced the potential loss of any benefit from those deductions.

The IRS has released this Revenue Procedure to provide an option for certain taxpayers to deduct these expenses in the following year if they had filed a return that did not claim the expenses.  But, as we will discover, it only gives relief for those who were following the then current text of the Internal Revenue Code at the time they filed the return.

Relief Provided

There are limits on this ability to claim the deductions in the following year, but it should cover those situations where taxpayers were otherwise looking at having to amend an already filed return, at least so long as the taxpayer’s return was filed on or before December 27, 2020.

Taxpayers who meet the requirements are given the following option:

…[A] taxpayer may elect to deduct otherwise deductible original eligible expenses on the taxpayer’s timely filed, including extensions, original Federal income tax return or information return, as applicable, for the taxpayer’s immediately subsequent taxable year, rather than on an amended return or administrative adjustment request for the taxpayer’s 2020 taxable year in which the expenses were paid or incurred…[5]

To be eligible, the taxpayer must be:

• A Covered Taxpayer (as defined in Section 3.02 of the procedure); and

• Satisfy all of the requirements found in Section 3.04 of the procedure.[6]

Covered Taxpayer

A Covered Taxpayer must meet all of the following requirements:

• The taxpayer received an original PPP covered loan;

• The taxpayer paid or incurred original eligible expenses during the taxpayer’s 2020 taxable year;

• On or before December 27, 2020, the taxpayer timely filed, including extensions, a Federal income tax return or information return, as applicable, for the taxpayer’s 2020 taxable year; and

• On the taxpayer’s Federal income tax return or information return, as applicable, the taxpayer did not deduct the original eligible expenses because —

  • The expenses resulted in forgiveness of the original PPP covered loan; or

  • The taxpayer reasonably expected at the end of the 2020 taxable year that the expenses would result in such forgiveness.[7]

The most significant thing to note is that any return filed after December 27, 2020 will not qualify for this relief.  Even though the IRS did not formally withdraw their prior rulings until January 25, 2021, the enactment of the COVID-related Tax Relief Act on December 27 overrode those IRS rulings.  Thus, the IRS will not provide relief to a taxpayer who may have filed the return on December 28, not yet having digested the entire 5,500 pages of the appropriations bill that contained the COVID-related Tax Relief Act as a portion of the much larger package.

Taxpayers who filed after December 27, 2020 or otherwise fail to meet the requirements of this procedure will need to amend the return for the year the expenses were incurred to be able to claim a deduction for them.

Expenses Not Covered by the Safe Harbor

The IRS also provided a list of expenses that won’t qualify for this safe harbor.  The expenses are expenses that would not have led to forgiveness under the prior law, but now are available for forgiveness under some provision enacted on December 27, 2020.

First, the IRS bars the expanded list of expenses that can be claimed to qualify for forgiveness for the first-draw PPP loans previously in existence:

Section 304(b)(2) of the Economic Aid Act expanded the list of expenses for which an individual or entity that received an original PPP covered loan could receive forgiveness. See § 7A(a) of the Small Business Act (as amended by § 304(b)(2) of the Economic Aid Act). However, because those new expenses were not included as part of the original eligible expenses, those expenses are not eligible to be deducted through an election by a Covered Taxpayer to apply the safe harbor provided by section 3.01 of this revenue procedure.[8]

As well, if a taxpayer has excluded expenses based on expected forgiveness under the second-draw PPP loan program created by the December 27, 2020 package, those expenses will not qualify for this safe harbor:

Section 311(a) of the Economic Aid Act amended § 7(a) of the Small Business Act to authorize Paycheck Protection Program Second Draw Loans (PPP Second Draw Loans) under the same terms, conditions, and processes as original PPP covered loans. See § 7(a)(37)(B) of the Small Business Act (as added by § 311(a) of the Economic Aid Act). PPP Second Draw Loans are not original PPP covered loans, and therefore eligible expenses that may result in forgiveness of such loans are not covered by this revenue procedure.[9]

Safe Harbor Limitations

The IRS notes that the agency is not giving up the right to challenge the expenses on other grounds, providing the procedure does not preclude the IRS from:

• Examining any issues relating to the claimed deductions for original eligible expenses, including

  • Determining whether a taxpayer is a Covered Taxpayer under this revenue procedure,

  • The amount of the deduction, and

  • Whether the Covered Taxpayer has substantiated the deduction claim; or

• Requesting additional information or documentation verifying any amounts described in the statement required by section 3.04(1) (the formal election described next) of this revenue procedure.[10]

Making the Election

As this procedure is optional, it must be elected by the taxpayer to be taken advantage of.  The IRS provides the following rules governing the time and manner of making the election.  A failure to satisfy the conditions imposed to make the election will invalidate the election.

The conditions that must be met are:

• Election deadline. A Covered Taxpayer must make the election by attaching the statement described in the following bullet to the Covered Taxpayer’s timely filed, including extensions, Federal income tax return or information return, as applicable, for the Covered Taxpayer’s first taxable year following the Covered Taxpayer’s 2020 taxable year in which the original eligible expenses were paid or incurred.

• Requirements for statement. The statement required by this revenue procedure must be titled “Revenue Procedure 2021-20 Statement” (and named RevProc2021-20.pdf for e-file attachments) and include the following information:

  • The Covered Taxpayer’s name, address, and social security number or taxpayer identification number;

  • A statement that the Covered Taxpayer is applying the safe harbor provided by section 3.01 of this revenue procedure;

  • 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 paid or incurred by the Covered Taxpayer during the Covered Taxpayer’s 2020 taxable year that are reported on the Federal income tax return or information return, as applicable, for the Covered Taxpayer’s first taxable year following that 2020 taxable year.[11]

[1] Revenue Procedure 2021-20, April 22, 2021, https://www.taxnotes.com/research/federal/irs-guidance/revenue-procedures/irs-provides-safe-harbor-for-some-ppp-loan-recipients/52gyq (retrieved April 23, 2021)

[2] Revenue Procedure 2021-20, April 22, 2021, Section 2.02

[3] Revenue Procedure 2021-20, April 22, 2021, Section 2.03(1)

[4] Revenue Procedure 2021-20, April 22, 2021, Section 2.03(2)

[5] Revenue Procedure 2021-20, April 22, 2021, Section 3.01

[6] Revenue Procedure 2021-20, April 22, 2021, Section 3.01

[7] Revenue Procedure 2021-20, April 22, 2021, Section 3.02

[8] Revenue Procedure 2021-20, April 22, 2021, Section 3.03(1)

[9] Revenue Procedure 2021-20, April 22, 2021, Section 3.03(2)

[10] Revenue Procedure 2021-20, April 22, 2021, Section 3.05

[11] Revenue Procedure 2021-20, April 22, 2021, Section 3.04