Rev. Rul. 2020-27

ISSUE

May a taxpayer that received a loan guaranteed under the Paycheck Protection Program (PPP) authorized under section 7(a)(36) of the Small Business Act (15 U.S.C. 636(a)(36)) (covered loan), and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Pub. L. No. 116-136, 134 Stat. 281 (March 27, 2020) deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan based on the otherwise deductible expenses?

FACTS

In each of the following situations, the taxpayer computes taxable income on the basis of the calendar year for federal income tax purposes and received a covered loan from a private lender in 2020.

Situation 1 . During the period beginning on February 15, 2020, and ending on December 31, 2020 (covered period), Taxpayer A (A) paid expenses that are described in section 161 of the Internal Revenue Code (Code) and section 1106(a) of the CARES Act (eligible expenses). These expenses include payroll costs that qualify under section 1106(a)(8) of the CARES Act, interest on a mortgage that qualifies as interest on a covered mortgage obligation under section 1106(a)(2) of the CARES Act, utility payments that qualify as covered utility payments under section 1106(a)(5) of the CARES Act, and rent that qualifies as payment on a covered rent obligation under section 1106(a)(4) of the CARES Act. In November 2020, pursuant to the terms of section 1106 of the CARES Act, A applied to the lender for forgiveness of the covered loan on the basis of the eligible expenses it paid during the covered period. At that time, and based on A’s payment of the eligible expenses, A satisfied all requirements under section 1106 of the CARES Act for

forgiveness of the covered loan. The lender does not inform A whether the loan will be forgiven before the end of 2020.

Situation 2 . During the covered period, Taxpayer B (B) paid the same types of eligible expenses that A paid in Situation

1. B, unlike A, did not apply for forgiveness of the covered loan before the end of 2020, although, taking into account B’s payment of the eligible expenses during the covered period, B satisfied all other requirements under section 1106 of the CARES Act for forgiveness of the covered loan. B expects to apply to the lender for forgiveness of the covered loan in 2021.

LAW

Section 1102 and 1106 of the CARES Act, established the PPP as a new loan program administered by the U.S. Small Business Administration (SBA) as part of its section 7(a) Loan Program (15 U.S.C. 636(a)) that was designed to assist small businesses nationwide adversely impacted by the COVID–19 emergency to pay payroll costs and other covered expenses. See Business Loan Program Temporary Changes; Paycheck Protection Program, 85 FR 20811 (April 15, 2020). Under the PPP, the SBA is permitted to guarantee the full principal amount of a covered loan. Under section 1102(a)(2) of the CARES Act, a covered loan is a loan made under the PPP during the covered period. A covered loan may be forgiven under section 1106 of the CARES Act, based on certain eligible expenses being paid or incurred during the covered period.

The covered period for making loans was initially the period beginning on February 15, 2020 and ending on June 30, 2020. See section 1102(a)(2) of the CARES Act. The Paycheck Protection Program Flexibility Act of 2020, Pub. L. No. 116-142, 134 Stat. 641 (June 5, 2020), extended the end date of the covered period for making loans from June 30, 2020 to December 31, 2020.

An individual or entity that is eligible to receive a covered loan (eligible recipient) can receive forgiveness of the full principal amount of the covered loan up to an amount equal to the following eligible expenses that are paid or incurred during the covered period: (1) payroll costs, (2) interest on a covered mortgage obligation, (3) any covered rent obligation payment,

and (4) any covered utility payment. See section 1106(b) of the CARES Act.

Under section 1106(i) of the CARES Act, for purposes of the Code “any amount which (but for [section 1106(i)]) would be includible in gross income of the eligible recipient by reason of forgiveness described in section 1106 shall be excluded from gross income.” Section 1106(i) of the CARES Act excludes the forgiven amounts from gross income regardless of whether the income would be (1) income from the discharge of indebtedness under section 61(a)(11) of the Code, or (2) otherwise includible in gross income under section 61 of the Code.

On May 2, 2020, the Department of the Treasury and the Internal Revenue Service (IRS) released Notice 2020-32, 2020-21 IRB 837 (May 18, 2020), which clarifies that no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of a covered loan. Notice 2020-32 relied on section 265(a)(1) of the Code and §1.265-1 of the Income Tax Regulations, which provide that no deduction is allowed for any amount otherwise allowable as a deduction to the extent the amount is allocable to one or more classes of income other than interest wholly exempt from the taxes imposed by subtitle A of the Code. See generally section 265(a) (1); §1.265-1. This rule applies “whether or not any amount of income of that class or classes is received or accrued.” Id . The term “class of exempt income” means any class of income that is either wholly excluded from gross income under any provision of subtitle A of the Code or wholly exempt from the taxes imposed by subtitle A of the Code under the provisions of any other law. See §1.265-1(b)(1).