On Wednesday, November 18th, the IRS issued Revenue Ruling 2020-27 clearly stating eligible expenses paid with PPP proceeds are not a tax deduction in 2020 if the borrower “has a reasonable expectation of forgiveness during 2020 or 2021.” This ruling applies whether the borrower submits an application for PPP forgiveness in 2020 or waits until 2021.
What does this mean for 2020 tax liabilities and planning? PPP recipients should consider if they have made sufficient estimated tax payments for 2020 to avoid any underpayment or late payment penalties. This should include a projection of 2020 taxable income and a determination if “safe harbor” amounts based on 2019 tax liabilities make the most sense. Additional tax payments can be made through a final quarterly estimate or payroll withholding if applicable.
Strategic tax planning before the end of 2020 is critical. It is important to maximize available deductions and credits as an offset to this unexpected increase in income. For those businesses who remain financially distressed, it is important to evaluate cash requirements and plan for the impact well ahead of April 15th. For profitable 2020 operations, the increased income may push taxpayers into a higher tax bracket, or limit tax deductions enjoyed in the past, creating an unpleasant surprise on April 15th. It is highly important to consider all available options to reduce the impact of these PPP proceeds, including considerations of cost segregation studies for construction or improvement projects; evaluation of R&D credit eligibility; equipment purchases, revenue deferral opportunities, acceleration of deductions, etc.
Is the PPP still a benefit? Should I pay it back? Keep in mind that even though the forgiven PPP proceeds are essentially taxable as a result of the non-deductibility of the expenses, the highest federal tax rate is 37%. For every $100 you received, you keep at least $63, excluding state tax impact. Your decision to pay back the loan should not be based on the taxability.
How does this impact when I should file for forgiveness? This guidance removes the question regarding timing due solely to tax consequences. Eligible expenses are excluded for the tax year 2020 regardless of when the taxpayer files for forgiveness.
What if my Loan is not forgiven? In addition to the Revenue Ruling discussed above, the IRS addressed this situation in Revenue Ruling 2020-51, providing a “safe harbor” for those who do not receive SBA forgiveness, receive only partial SBA forgiveness, or irrevocable decide not to seek SBA forgiveness. In these cases, the taxpayer will have the ability to deduct the eligible expenses in either 2020, 2021, or the year that notice of denial is received from the SBA. This will require the attachment of a required statement titled “Revenue Procedure 2020-51” to the tax return on which the expenses are deducted.
Please reach out to your Somerset Advisor for assistance in applying this new guidance to your unique situation. If you do not work with Somerset, now is a great time to become acquainted. You may contact us at 317.472.2200 or with any questions. We are here to help you!