As part of an economic stimulus to assist small and mid-size businesses impacted by the Coronavirus pandemic, the CARES Act established the Paycheck Protection Program (“PPP”). The PPP was designed to provide a direct incentive, in the form of a forgivable loan, for businesses to keep their employees on the payroll. For the loan to be forgiven, PPP loan recipients must meet certain criteria, including spending at least 60% of the loan on payroll expenses.
PPP loan recipients should be aware that PPP loan forgiveness may cause otherwise Qualified Research Expenses (“QREs”) to become ineligible for the R&D Tax Credit for Tax Year 2020. Earlier this year, the IRS released Notice 2020-32 which stated that expenses paid using forgiven PPP loans would not be deductible for tax purposes. Most recently, the IRS reaffirmed its stance regarding PPP loan forgiveness and the deductibility of related PPP expenses with the release of Rev. Rul. 2020-27 and Rev. Proc. 2020-5. Rev. Rul. 2020-27 confirms that a taxpayer may not deduct PPP expenses, such as payroll costs, if the PPP loan is “reasonably expected” to be forgiven. Rev. Proc. 2020-51 provides a safe harbor for taxpayers to claim a deduction in Tax Year 2020 if the taxpayer expects the loan to be forgiven after 2020 and if the taxpayer’s application for forgiveness is denied. Although not expressly addressed in the IRS guidance one should safely assume the IRS will also interpret otherwise Qualified Research Expenses paid with forgivable PPP funds will no longer be includable in the research credit.
Considering the recent IRS guidance, taxpayers should understand that it is still possible for Congress to pass legislation making PPP spend deductible, as this was Congress’ intent with the passing of the CARES Act. Research credits can be quite lucrative for any size business. With an expert understanding of these and other tax provisions, taxpayers can plan to mitigate the effects of PPP loan forgiveness and the R&D Tax Credit by applying PPP funding to expenses other than Qualified Research Expenses. Taxpayers may also consider delaying or even forgoing application for PPP loan forgiveness. Taxpayers should consider speaking to their tax planner about what is best for their company’s particular circumstances.
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