Taxability of PPP Loan Forgiveness

Many businesses took advantage of the government's Paycheck Protection Program (PPP) in 2020.  The program allowed businesses to acquire forgivable loans to help keep their doors open and employees working.  Normally, when loans are forgiven, it gives rise to taxable income.  Congress was aware of this and intended the loan forgiveness to be non-taxable.  However, they did not write the law correctly, and ran afoul of an existing tax law regarding tax-exempt income. 

The IRS ruled (Notice 2020-32) that the forgiveness is tax-exempt income, and accordingly, any expenses that give rise to that income cannot be deducted.  Since the PPP loan will only be forgiven if used for certain expenses, those expenses cannot be deducted, in effect making the loan forgiveness taxable. 

In the meantime, the question arose regarding WHEN the expenses would have to be excluded from the calculation of taxable income.  For instance, a calendar-year taxpayer will have qualifying expenses in 2020, but they may not receive loan forgiveness until 2021.  So does the taxability take place in 2020, when the qualifying expenses are made, or in 2021, when the loan is actually forgiven? 

Last week the IRS issued two rulings (Rev. Rul. 2020-27 and Rev. Proc. 2020-51) that clarify the situation.  They made clear that regardless of when the loan is forgiven, if at the end of the year the taxpayer reasonably expects to have the loan forgiven, then the expenses must be excluded in 2020, making the loan proceeds taxable in 2020, even if the loan is not forgiven until 2021.  Obviously, the result is the same if the loan is forgiven in 2020. 

But what if the taxpayer expects forgiveness in 2021, but the taxpayer either changes their mind or the bank does not approve the forgiveness?  The IRS says the taxpayer may deduct the expenses in the year incurred on either an original or amended return. 

A slim chance exists that Congress will correct the law they passed and reinstate tax-free forgiveness.  Stay tuned for further developments, but in the meantime, taxpayers should expect to pay tax on the forgiven loan. 

Contributed By: Mark Westerhausen, CPA | Director | DWD CPAs & Advisors