Rev Proc 2021-49: Safe Harbor for PPP Expense Deductions

The Paycheck Protection Program (PPP) created confusion about whether expenses paid with a forgiven loan could be deducted on a federal income tax return. Initially, the Internal Revenue Service (IRS) stated these expenses were not deductible, based on the principle that expenses tied to tax-exempt income are not deductible. This stance created an unanticipated tax burden, reducing the financial benefit of loan forgiveness.

In response to legislative action, the IRS released Revenue Procedure 2021-49. This guidance established a “safe harbor” for certain taxpayers, outlining specific conditions under which businesses could deduct these expenses. It provides a path for those who had their PPP loan forgiveness denied or chose not to seek it.

Eligibility for the Safe Harbor

To use the relief provided by Revenue Procedure 2021-49, a business must qualify as a “covered taxpayer.” The first requirement is that the taxpayer received a PPP loan and paid or incurred eligible expenses, such as payroll costs, mortgage interest, rent, and utility payments.

The main conditions for eligibility revolve around the status of the loan forgiveness application. A taxpayer qualifies if they applied for forgiveness, but the lender or the Small Business Administration (SBA) denied the application in whole or in part. A taxpayer who withdrew their forgiveness application before a decision was made is also eligible.

The safe harbor also extends to taxpayers who decided not to apply for PPP loan forgiveness at all. This could include situations where a business determined the record-keeping was too burdensome. By meeting one of these conditions, a taxpayer becomes a “covered taxpayer” and can deduct their eligible expenses.

Understanding the Deduction Timing Options

Revenue Procedure 2021-49 provides flexibility by offering different options for the timing of expense deductions. The guidance outlines three distinct scenarios. The first applies to taxpayers who paid expenses in one taxable year but did not receive a final decision on their forgiveness application by the end of that year. If the application is later denied or withdrawn in a subsequent year, the taxpayer has a choice. They can deduct the expenses on an amended return for the year the expenses were paid or on the tax return for the year the forgiveness was denied or withdrawn.

The second scenario addresses taxpayers who paid expenses and had their forgiveness application denied or withdrawn all within the same taxable year. For these taxpayers, the path is more straightforward, and they are permitted to deduct the eligible expenses on the tax return for that specific year.

The third scenario covers taxpayers who paid expenses in a taxable year and had decided by the end of that year that they would not be seeking forgiveness. In this situation, the taxpayer can deduct the expenses on their tax return for the year the expenses were paid.

How to Make the Safe Harbor Election

To elect the safe harbor under Revenue Procedure 2021-49, a taxpayer must attach a specific statement to their federal income tax return for the year the deduction is being claimed. This is a taxpayer-created document, not a pre-printed IRS form. The statement must be labeled “Revenue Procedure 2021-49 Statement” at the top.

The body of the statement must include the following information:

• The taxpayer’s name, address, and Social Security Number or Employer Identification Number.
• A declaration that the taxpayer is a “covered taxpayer” as defined in the revenue procedure and is applying the safe harbor.
• A statement specifying which of the eligibility conditions they meet.
• The amount of the PPP loan and the amount of expenses being deducted.
• The taxable year in which those expenses are being claimed as a deduction.

This completed statement must be attached to the relevant tax return. This could be an original return, an amended return (Form 1040-X, 1120-X, etc.), or an Administrative Adjustment Request (AAR) for certain partnerships.