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PPP Loan Tax Returns: What We Know Now

PPP loan tax returns will require special handling and extra planning.

The IRS provided additional rules for PPP loan tax return preparation this week.

In this short post, therefore, I want to review what we now know about how tax returns handle PPP loan transactions.

Then, I’ll share my thinking about how we report this PPP loan activity on tax returns. But let’s start with the statutes and then the administrative guidance.

Two Statutes Matter: Section 1106 and Section 265

Congress wrote two laws that set the stage for how PPP loan tax returns work.

Everybody paying attention to paycheck protection program loans knows about one of those statutes, Section 1106 of the CARES act. It said forgiveness of the PPP loan didn’t count as taxable income.

A second statute, Section 265, many folks initially ignored (including me but let’s keep that under our hats.) It says amounts paid with nontaxable income don’t go on a tax return as a deductions.

Combine these two statutes and taxpayers end up with a common sense result: A taxpayer doesn’t pay income taxes on the PPP loan funds—even though usually cancellation of debt creates income.

But the expenses paid in effect by the Federal government through the PPP loan? Yeah, you didn’t actually pay those. So you don’t get the deduction.

In Notice 2020-32, the IRS patiently explained how the puzzle pieces fitted together here. And then at that point, some taxpayers, maybe most tax accountants, and even a few members of Congress began complaining.

Revenue Ruling 2020-27 and Revenue Procedure 2020-51

That complaining I mentioned? Hopes ran high that the Treasury and Internal Revenue Service would relent and give taxpayers an even bigger break. People not only wanted free money. They wanted tax deductions for spending that free money.

On November 18, 2020, the IRS published two new rules. And dashed hopes.

In Revenue Ruling 2020-27, the IRS said taxpayers do not get deductions for amounts paid with PPP loan proceeds if the taxpayer anticipates receiving forgiveness.

And then in Revenue Procedure 2020-51, the IRS dealt with the obvious real-life wrinkle: a taxpayer doesn’t receive PPP forgiveness. What Revenue Procedure 2020-51 says is this: If you don’t get forgiveness for some bit of PPP-loan spending or for some reason decide not to apply for forgiveness, you predictably do get to deduct.

The Revenue Procedure then outlines the various ways you can “get” the deduction onto a PPP loan tax return. The IRS basically allow the approaches you would guess.

You can deduct “unforgivable” 2020 spending on your original 2020 return. Or you can amend your 2020 return later on.

Alternatively, you can deduct on your 2020 spending on 2021 original return—or an amended 2021 return.

Finally, partners in a partnership can deduct using an administrative adjustment request (AAR) under section 6227.

What All This Means for PPP Loan Tax Returns?

Let me share my thoughts on the above. I’ve had a couple of days to process the new guidance and organize my thinking. But also, if you’re a tax practitioner or a PPP loan borrower, feel free to disagree or make other comments.

First, regarding the chatter from members of Congress who don’t like the way the accounting works? (I’m thinking, for example, of Senators Grassley and Wyden.) I say we ignore that. We can’t plan based on that chatter.

Note: If Congress really wanted to get the tax accounting result Grassley and Wyden want, it needed to rewrite Section 265. As those boys know. Or should know.

Second, taxpayers need to have prepared their PPP loan forgiveness application before the tax return can be prepared. The 3508 form becomes the source document required to determine the appropriate deductions on  a PPP loan tax return. My thought is that taxpayers file their 2020 returns based on the 3508 form they complete, then. I don’t think they wait until they receive confirmation of the actual forgiveness amount.

Note: A lender gets 60 days to process the forgiveness application. The SBA gets 90 days to review the application.

Third, tax accountants need to plan that the PPP loan tax returns will require a bit more work. Using the information shown on the PPP loan forgiveness application, tax accountants will need to adjust deductions. Further, if a PPP loan tax return deducts amounts paid with unforgiven PPP loan proceeds, the tax return needs to include a safe harbor statement as per Revenue Procedure 2020-51. Tax accountants want to allow time for extra effort.

Note: Unless I hear otherwise, I’m thinking a single adjustment shown as a negative “other expenses” amount. For example, someone with a $50,000 PPP loan might report a ($50,000) negative expense.

Fourth and final, taxpayers facing uncertainty about PPP loan forgiveness should simply extend their tax return due dates. The tax accountants all know this intuitively, of course. But some taxpayers unaccustomed to extensions will need to be encouraged to extend until after they’ve finished their 3508 PPP loan forgiveness application. And maybe even until after they receive confirmation of the forgiven amount.

Other Resources

Preparing 3508S PPP Loan Forgiveness Application

PPP Loan Tax Accounting for Sole Proprietorships and Partnerships

For fun, CPAs may be interested in this blog post about one of the most profitable single owner CPA firms in the country: Small Business Compound Growth: The Long Game.

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