Timing of PPP expenses

And between loan and fixed right of reimbursement there is usually. difference in whether/how/from when interest if any is calculated.

https://www.irs.gov/pub/irs-drop/rr-20-27.pdf

and https://www.irs.gov/pub/irs-drop/rp-20-51.pdf

So is IRS 20-27 saying that eligible expenses ( payroll, rent, utilities ) would not be deducible in 2020 because there is a
reasonable expectation of reimbursement and formal SBA loan forgiveness in 2021?

In both Situation 1 and Situation 2, A and B each have a reasonable expectation of reimbursement. At the end of 2020, the reimbursement of A’s and B’s eligible expenses, in the form of covered loan forgiveness, is reasonably expected to occur – rather than being unforeseeable – such that a deduction is inappropriate.

Fascinating logic, that bit about “reimbursement…in the form of covered loan forgiveness.” Since when is the act of forgivenesss a reimbursement? Reimbursements are made in cash. And in the case of the PPP, that cash came up front, much like an employer that advances $X to its employee for an upcoming business trip.

That Canelo case was one involving a lawyer that paid various costs on behalf of the client and then the client LATER reimbursed the lawyer. To liken Canelo to the PPP situation, we would need Canelo’s client to first advance funds to Canelo (just like the government first advances funds to the employer under the PPP). Next, when Canelo pays the expenses, Canelo would debit Payable to Client and credit Cash. If all money in to Canelo equals all money out from Canelo, nothing hits Canelo’s P&L. And there is no more “Payable to Client” on Canelo’s Balance Sheet. Thus, there is nothing to forgive. But even if the client sent Canelo a letter saying, “I see that you have properly expended all funds I advanced to you for case costs. Therefore, I forgive, from repayment, all amounts that I advanced to you up front”…that meaningless gesture wouldn’t amount to a reimbursement. The “reimbursement” comes up front in the PPP situation. But if you disagree and urge us to look at the timeline, such that your argument is that the “reimbursement” takes place when we pay a qualifying PPP expenditure - because it is at that moment that we make our journal entry to debit “Payable to Client” - then fine. That point in time is still before the date on which the loan is formally forgiven.

In a nutshell, the Rev Rul would have us believe that the “reimbursement” takes place when the loan is forgiven. Of the three possibilities (when the cash is initally advanced, when the employer pays a qualifying expense, forgiveness) that is the one possibility that doesn’t make any sense. So, there is flaw in the IRS’ logic here. Now, if this flaw didn’t exist, and the IRS actually picked the right date in the Rev Rul as the reimbursement date, the IRS would still end up with the same conclusion, it’s just that their conclusion would be better reasoned. That would be a consistent IRS argument in favor of the Right of Reimbursement theory. At that point, I would refer you back to some of the comments I made in Post #50, for example.

Thanks Jeff. back to my question -Is IRS 20-27 saying that eligible expenses ( payroll, rent, utilities ) would not be deducible in 2020 because there is a reasonable expectation of reimbursement and formal SBA loan forgiveness in 2021?

Interesting stuff there Jeff. They really went heavy on law firm cases in the area of right to reimbursement, which as you say just doesn't fit with these circumstances. I agree with you.

I also notice the Treasury cited dicta about an "unforseen" circumstance in Hillsboro (Bliss Dairy) to compare with Canelo which dealt with events reasonably-expected-to-occur to justify why the tax benefit rule does not apply. One problem here is that SCOTUS in Hillsboro did not weigh in on "unforseen" (hence dicta), they only weighed in on drawing the line between unexpected events and inconsistent events.

[i]
In a nutshell, the Rev Rul would have us believe that the “reimbursement” takes place when the loan is forgiven. Of the three possibilities (when the cash is initally advanced, when the employer pays a qualifying expense, forgiveness) that is the one possibility that doesn’t make any sense. So, there is flaw in the IRS’ logic here. Now, if this flaw didn’t exist, and the IRS actually picked the right date in the Rev Rul as the reimbursement date, the IRS would still end up with the same conclusion, it’s just that their conclusion would be better reasoned. That would be a consistent IRS argument in favor of the Right of Reimbursement theory. At that point, I would refer you back to some of the comments I made in Post #50, for example.

That is awesome! and interesting.

I think they, IRS, still have a possibility of losing in court because nothing really fits this set of facts. And with respect to the reasonably expect to occur argument. That argument fails to recognize how much the PPP program has been moving around. Just a few weeks ago a questionairre form came out for 2M+ borrowers drilling down on their need for the loan. Has the SBA confirmed they intend for that form to submittted. Not sure if they have yet. There are still other uncertainties I'm waiting clear before I recommend clients apply for forgiveness. And it's not just one thing it's basically i'm waiting for the program to stop moving around. This is the reality of our expectation.

Thanks Terry. But how should we proceed with preparing 2020 tax returns ? Should we not deduct eligible expenses in 2020 because there is a reasonable expectation of reimbursement and formal SBA loan forgiveness in 2021?

That's basically the plan because although I enjoy the debate i'm not one to try and find the line in the sand with my clients, and after all there is the safe harbor rev proc which allows a deduction if full forgiveness is not determined later. While i'm not sure about the timing, it's one way of correcting the inconsistencies. However, the reason these developments are important is because it all move the process along to eventually, what I'm hoping for, is congress steps in. And that's possible because the IRS is not on solid ground here and I'm sure the AICPA will respond soon enough.

Philly, I have proceeded by writing to my congresscritters. Why not do the same? If enough of us pester them, we may get a result. Maybe I am fortunate, but I have had good responses, including several telephone calls from their congressional offices on various matters over the years.

Good idea SumwunLost. The issuance of rev Ruling 20-27 might encourage Congress to address this issue.

House and Senate have bills allowing deduction of these expenses. The bills have been sitting since May. Talk (per AICPA political affairs yesterday) is the language would be added to other bill(s), such as the funding bill.

Did the AICPA say that it would or could be in a later bill?

The next funding bill needs to be passed by December 11 to avoid a shut down. The Govt doesn't usually fix things during funding bills if they can defer it until later.

AICPA said they did not think the expense deduction would pass as a stand alone bill.
They said it would be added to something else, and the devil will be to get House and Senate to agree on the whole bill. They both agree on this item.

EDIT: Today AICPA said it will likely be part of the next stimulus package, which may not be until January.

This is what the Canelo case says:

Petitioners correctly point out that under respondent's view of these transactions, if the advances are “loans” rather than expenses when paid, they are not income when recovered. Income is not offset by something from an earlier year; there is no income. After recovering the advances the petitioners have no more than they started with, so the recovery by itself does not create taxable income.

Jeff, what you're saying is starting to sink in. If we consider reimbursement theory where the initial advance is the funding of a ppp loan. Then when the conditions for forgiveness are met and we qualify for forgiveness why did Congress call it income and say it would not be taxable if under the Canelo view there is no income when you finally get reimbursed (or forgiveness).

Correct me if I'm wrong, but the treasury appears to be grasping for straws. I'm starting to consider this notice lacking a reasonable basis. Not that they may not win in court, but if this goes to court and the government wins they would have prevailed by applying right-of-reimbursement theory in a new and different way, never done before. Which is why i say they do not seem to have any authority that supports their conclusion. Further as you and other commentators are beginning to point out it flies in the face of what appears to be clear in that Congress designed the program to be a loan with the expectation it would be repaid if not spent according to certain conditions. So treasury is putting forth altogether new concept, let's call right-of-forgiveness theory. Now if they came right and said that many of us would be like, there is no such theory. So instead they came out with a way to introduce a totally new idea that resembled other transactions.

and then there's this https://thehill.com/policy/finance/5267 ... -ppp-loans

Ok with that I'm not looking at anymore cases. Lol.

Does this matter?

Cares Act Section 1106(c)(1) provides:

In general.—Amounts which have been forgiven under this section shall be considered canceled indebtedness by a lender authorized under section 7(a) of the Small Business Act (15 U.S.C. 636(a)).

My guess is that it may not matter at all because Congress' inention run unambigously through out the Act that the PPP program is a loan. What i'm trying to do now is flesh out the issue of what it is that we don't have an answer to. Broadly put is the PPP expenses nondeductible is not the actual question a court would settle.

1) Can an item of income be a reimbursement, under the ROR theory?
2) Does ROR theory apply in the case of PPP loan program?

roughly that's where i'm at.

Hey according to the IRS in Revenue Ruling 87-117 income can be a reimbursement; although reimbursement theory did not apply in that RR. They did point out that income can be a reimbursment, but that "the type of compensation received must be such that it was structured to replace what was lost"

Apparently disaster loans have been forgiven before AND the IRS applied reimbursement theory before, but unfortunately doesn't look like they straddled two years. bummer.

https://casetext.com/case/shanahan-v-co ... al-revenue
James A. Shanahan and Constance M. Shanahan v. Commissioner
U.S. Tax Court, Docket No. 1090-73, 63 TC —, No. 4, 63 TC 21, Filed October 15, 1974

Petitioners maintain that they were not compensated by the cancellation of indebtedness because it was a gift. Respondent has stated, in prior Revenue Rulings, that the Government is capable of making a gift 4 and that a gift to disaster victims by relatives is not considered as compensation for purposes of section 165. 5

Respondent relies on Rev. Rul. 71-160, 1971-1 C. B. 75 6 which takes the position that the forgiveness of indebtedness provisions of the Disaster Relief Acts of 1969 and 1970 are similar to insurance and that “the purpose of these provisions is to compensate disaster victims for certain property losses”, thus concluding “that the portions of the debts cancelled under the Act are ‘compensation’ within the meaning of section 165(a) of the Code.”