Do Your Tax Planning for PPP Loan Forgiveness

November 6, 2020 by Leave a comment

Many of ASA’s members obtained PPP Loans, which had been authorized under the CARES Act. One important feature of the loans is the ability to seek loan forgiveness.

Last month the Small Business Administration posted new guidance on PPP loan forgiveness. The new guidance is still incomplete, and leaves a lot of questions unanswered; but it is meant to allow banks to start the process of accepting loan forgiveness applications.

Many banks are still not yet accepting loan forgiveness applications. The Small Business Administration just posted an updated application package for PPP loan forgiveness on Saturday, October 31. So we should expect movement in this area, very soon.

But the question for the ASA Community is. “should I file for loan forgiveness when my bank says it is ready, or should I wait until I am ready?” Filing for loan forgiveness may have tax consequences, and the precise nature of those consequences is still unclear because IRS guidance has suggested a complicated tax treatment for loan forgiveness (in their defense, the complicated tax treatment is based on pre-existing complicated tax laws).

With this in mind, we recommend that you take a strategic approach to the process of PPP loan forgiveness.

STEP ONE: Identify your Covered Period

For PPP loan forgiveness purposes, the Covered Period is a period that starts on the day you received the PPP loan. For example, if you received your PPP Loan on June 25, 2020, then that is the first day of the Covered Period.

The Covered Period lasts for either 8 weeks or 24 weeks. This is because the CARES Act set the Covered Period as an eight week period, but then Congress amended the law so that the Covered Period became a 24-week period. Those who got PPP loans before the change were allowed to choose either option:

  • If you got your PPP loan on or before June 4, 2020, then you get to choose whether your Covered Period is 8 weeks or 24 weeks (whichever one is more optimal for you).
  • If you got your PPP loan on or after June 5, 2020, then your Covered Period is 24 weeks.

For example, if your PPP loan was distributed on June 25, 2020, then you would be subject to a 24-week Covered Period which would end on December 10, 2020.

STEP TWO: Identify the date that is ten months after the last day of the Covered Period

The date that is ten months after the last day of the Covered Period is your deadline for filing the loan forgiveness application. Note that this date is likely to be in 2021 for most recipients. A 2021 deadline typically means that you can file for loan forgiveness in 2020, or you can file in 2021.

If we continue to use the same example period, above, and your Covered Period starts on June 25, 2020 and ends on December 10, 2020, then you will need to submit your loan forgiveness application within ten months, by October 10, 2021.

STEP THREE: Start assembling the loan-forgiveness documentation now.

On August 4th, we advised the community to start thinking about assembling their loan-forgiveness documentation. That blog post links to a PPP loan forgiveness video that ASA produced to help guide members as to the documentation that they should be assembling to support the PPP loan forgiveness application.

Even if your bank is not yet accepting loan forgiveness applications, by assembling the appropriate documentation you can give yourself more flexibility to file the application when you want to do so. You will be able to make a decision about filing optimal dates and then immediately be able to follow-through on the application.

STEP FOUR: Watch for more details!

The law and guidance in this area continues to change. As previously mentioned, there is a conflict between Congress’ apparent tax-free intent and the IRS’ guidance on the matter (which makes the consequence of loan forgiveness to be substantially the same as if the loan forgiveness was treated as income).

New guidance continues to be issued by the SBA and Treasury. So it makes sense to contonue to watch that new guidance (and watch this blog) to identify how the changes in policy might affect your decisions

STEP FIVE: Make an intelligent decision about when to file your loan forgiveness application

An important part of making the intelligent decision is to consult with appropriate tax lawyers and accountants about the tax-effect your decision might have.

Unless the law is changed, the loan forgiveness will not be taxed as income, but the wages paid by the loan will not be allowed to be deducted as ordinary-and-necessary business expenses. For most businesses, this should yield a result that is equivalent to treating the loan forgiveness as income, but also treating the permitted expenses that were paid out of that loan as deductible expenses (the way that PPP loan forgiveness works is more complicated from a tax accounting perspective).

Normally (for accrual taxpayers) the loan forgiveness would not count as income until you file for forgiveness, and the forgiveness application is accepted. Similarly, the deduction for the wages paid from the loan would not be accrued as a deduction until three elements are met:

  • all the events have occurred that establish the fact of the liability,
  • the amount of the liability can be determined with reasonable accuracy, and
  • economic performance has occurred with respect to the liability

This is called the “all-events test.” If it is uncertain whether the wage payment might be deductible, then it is possible that the all-events test could prohibit someone from accruing a deduction for the payment until it was clear that the deduction could be accrued (which might have the effect of postponing accrual of the deduction for 2020 wages paid from the PPP loan until 2021 if the PPP loan forgiveness is not established until 2021. This is something that you should review with your tax accountant to see whether it might apply to your own tax situation.

As you can see, tax treatment of the amounts subject to the PPP is a complicated situation – while we await further IRS guidance about this, it is important to chose whether loan-forgiveness in 2020 or 2021 is preferable The availability of IRS guidance could be a factor that impacts this decision.

STEP SIX: File your loan forgiveness application when it makes the most sense to do so, for your business

Once you’ve consulted with your tax accountant on the optimal way to approach loan forgiveness, and once you’ve reviewed all of the latest guidance from the US government, then you will select a date range that makes sense in which to file your application. Don’t forget to file within ten months after the end of your Covered Period!

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PPP Amendments Make It Easier to Get Loan Forgiveness

June 5, 2020 by Leave a comment

Many of you have heard that Congress has passed a bill that would change some of the standards associated with the Paycheck Protection Program (PPP).

H.R.7010 is entitled the “Paycheck Protection Program Flexibility Act of 2020.”  That bill was signed into law today by the President.  We have a short status update at the bottom of this post.

The Changes

The bill features a number of important changes to the CARES Act Paycheck Protection Program (PPP) and the loan forgiveness program associated with it.

Covered Period for Spending and Loan Forgiveness

The covered period is changed in two different places in the new law.

First, the covered period for basic PPP program is changed the so that it ends at the end of the year (not June 30, 2020) as originally established.  Technically, this covered period is the period during which applicants can seek a loan.  More importantly, this is also the period during which PPP funds may be expended.  So, companies that were worried about whether they could pay out the money they received for PPP loans (on authorized expenses), will have a longer period for spending that money.

Second, the covered period for purposes of PPP loan forgiveness is also changed.  This is slightly more complicated.  For loan forgiveness purposes the covered period will end on the earlier of (A) 24 weeks after PPP loan origination or (B) December 31, 2020.

How will this work?  Let’s say that you received a PPP loan on April 28, 2020.  The 24-week period should end on or about October 12.  This means that you would have until December 31 to spend the PPP money to comply with the loan program requirements, but if you want to obtain loan forgiveness for the loan then you would need to spend the money on forgivable expenses by the earlier deadline of 24 weeks after PPP Loan origination (in this hypothetical that begins with an April 28 loan origination, October 12, 2020 appears to be the last day for forgivable expenditures).

Thus, for most PPP businesses (who intend to seek PPP loan forgiveness), it will be important to spend the PPP Loan on forgivable expenses by the 24th week after the loan origination.  For many businesses, this means spending the money on verifiable forgivable expenses before the 24-week anniversary of the loan origination.

But if you get a late PPP loan (a loan that is originated after July 16, 2020), then your ‘spend period’ and ‘forgiveness period’ will be the same.  Both would end on December 31, 2020; so, your total time period may be less than 24 weeks.

One other note on the covered period.  If you received your loan before June 5 (the date of enactment) and want to elect to retain an eight week period as your covered period then may elect to do that (retaining a covered period that begins on the date of the loan origination).

Minimum Floor – 60% of PPP Must Be Spent on Payroll to Obtain Forgiveness

Under the original law, one generally wanted to spend a certain percentage of the loan on payroll and spend no more than a certain percentage of the loan on authorized non-payroll expenses like rent. This was because the loan program was designed to set a maximum loan based on 80% payroll and 20% other expenses (like rent).  Assuming your headcount remains the same, you keeps salaries at 75% or more of spending from the reference period in order to maximize your potential for forgiveness.  Everyone’s numbers are different but in an ‘optimized’ situation, that meant keeping your payroll at about 60% of the loan amount (or more) in order to maximize forgiveness.  Under the old law, anything less would likely be subject to a reduction in forgiveness.

Treasury regulations applied a flat 75% test, requiring 75% of the funds provided to be spent on payroll if you intended to seek forgiveness.  This interfered with the numerical simplicity of the ‘optimized’ situation.  The new law returns the 60% threshold as the minimum amount that must be spent on payroll in order to qualify for forgiveness.

For those who do spend less than 100% of the PPP Loan on payroll, the new law imposes a “60% floor” for those who seek loan forgiveness.

The new law sets a minimum threshold that requires at least 60% of the PPP be spent on payroll, or else you lose all possibility of loan forgiveness.  You can still spend 100% of the PPP loan on payroll without penalty – you don’t need to hit the 60% mark exactly – but if you spend less than 60%  of your PPP loan on payroll then you may be ineligible for loan forgiveness.  This does means you can spend up to 40% of your PPP Loan on other forgivable expenses (covered mortgage interest, covered rent, or covered utility payments) and still get some or all of your loan to be forgiven.

What if I Can’t Rehire Employees?

The PPP loan forgiveness program also has a reduction in the percentage of a loan that can be forgiven for businesses that lose headcount as compared to their previous headcount. The comparison period is either February 15, 2019 – June 30, 2019, or January 1, 2020 – February 29, 2020 (at the option of the borrower).  If your average headcount in the comparison period was 40 and your average headcount in the covered period, today, is 30 then the maximum loan forgiveness would be reduced to 75%.

A concern expressed by a number of ASA members has been that they are seeking to rehire furloughed/laid-off workers and those workers refuse to return (for a variety of reasons, including because of fears about continuing danger from Covid-19, and because of lucrative unemployment benefits currently offered pursuant to the CARES Act).  Thus, they are encountering difficulties in returning to the higher numbers based on this refusal.

The new law provides a safe harbor for businesses that make a good faith effort to rehire, but are rebuffed by the past employee.  To make use of this safe-harbor, the employer must be able to document that it has tried and failed to rehire individuals who were employees on February 15, 2020; and that it has also tried and failed to hire similarly qualified employees for the unfilled positions on or before December 31, 2020.

As an alternative, the new law also permits the employer to document an inability to return to the same level of business activity (as compared to the level of activity as of February 15, 2020) due to certain legal compliance requirements (e.g. if CDC rules or OSHA rules would preclude a return to work).  This latter provision is unlikely to apply to most members of the ASA community, but it would apply to businesses that cannot return to work because inability to engage in social distancing makes the job dangerous for employees.

Interest Deferral

Under the original provisions, interest on the PPP loan was deferred for six months.  The new law changes this so that interest is deferred until the you apply for the loan forgiveness and tell the bank the amount of loan forgiveness to which you are entitled.  After you apply for loan forgiveness the law requires a decision within 60 days about whether loan forgiveness is warranted.  The new law is a little vague on whether interest accrues during this 60-day period – it is likely that this question will be answered in regulations.

Don’t look at this provision and think that if you never apply for loan forgiveness then your obligation to pay the loan back never applies.  The law set up a ten-month limit.  If you haven’t applied for PPP loan forgiveness within 10 months after the last day of the covered period, then you will need to start making payments of principal, interest, and fees on the loan beginning 10 months after the last day of the covered period.

If the PPP Funds Remain as a Loan …

PPP loans can remain unforgiven (it is legal to use them on certain non-forgivable expenses).  In such a case it becomes a low-interest loan.

The new law establishes a minimum maturity of five years for loans that remain unforgiven (the original bill set 10 years as a maximum, so this means the term for remaining unforgiven portions of loans will be 5-10 years).

Tax Status Not Fixed

Congress anticipated that the PPP would be forgiven if the payroll-related purposes of the PPP loan were met. To ensure that the debtor doesn’t need to pay extra taxes for this life-line, Congress explicitly stated that the forgiven amount is not included in gross income.

Congressional intent was thwarted by IRS Notice 2020-32 which explains that 26 U.S.C. § 265 disallows a deduction to a taxpayer for any amount that is allocable to income that is exempt from income taxes. The IRS Notice interprets this to mean that the expenses on which the forgiven loan is spent become non-deductible expenses.

The net result of the IRS Notice for many businesses would be the same as if they had treated the loan forgiveness as taxable income in the first place.  This issue has not been addressed in the new law.

Bills to address this concern have been introduced in the House (H.R.6821) and Senate (S.3612).  A full analysis of this provision is found here.

Status

The House passed H.R. 7010 on May 28 by an overwhelming vote of 417-1.  The bill has been held up in the Senate, where Senators Lee and Johnson have expressed concerns with some details in the bill.  They feel that the bill was intended to be a short-term solution and that loan applications should be limited to Aug. 15 (not through the end of the year).  The concerns were resolved and the bill was passed in the Senate.  The next step is for the President to sign it.  There is no reason to believe that the President won’t sign the Bill into law.

Update: The President signed the bill into law this afternoon.  June 5, 2020

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