PPP Loan Forgiveness: Authorized Expenses Paid With PPP Money Are Deductible

December 29, 2020 by Leave a comment

Many of our readers took advantage of the Paycheck Protection Program (PPP), which offered forgivable loans to businesses that were wiling to use the money for payroll purposes.

One open question was the tax treatment of the covered expenditures. An IRA Notice explained that the expenses would not be deductible, which reduced the total value of the PPP forgiven loan. That issue has been resolved in the recent Omnibus Bill. This issue presents itself like this:

  • First, under normal circumstances, loan forgiveness is taxable. You treat it like taxable income.
  • Second the CARES Act explicitly provided that loan forgiveness for CARES Act PPP loan forgiveness would not be taxable as income.
  • Third, the IRS released an interpretation – IRS Notice 2020-32 – explaining that although the PPP loan forgiveness would not be taxable as income, the payroll and other expenses paid with this money would also not be deductible. This was based on 26 U.S.C. § 265. You can see a complete analysis in our earlier article, here. For most taxpayers, this yielded the same result as if the PPP loan forgiveness had been taxable as income, and the payroll and other expenses had remained deductible.
  • Finally, this issue was resolved in the recent legislation, which confirmed that:
    • The CARES Act PPP loan forgiveness would not be taxable as income, as originally intended; and
    • The authorized expenses paid for with the forgiven PPP loan funds would remain deductible, without regard to 26 U.S.C. § 265.

In general, this means that the once the PPP loan has been forgiven, it will generate no additional tax liability, and it will not affect the deductibility of your payroll and other expenses. This makes PPP Loan forgiveness even more valuable to the taxpayers that receive it.

For those who apply for a second draw PPP (which will soon become available), comparable forgiveness and deductibility rules will apply. Se our article on the second draw PPP for more details.

This statutory authority can be found in Division N, Section 276 of the Omnibus bill (the particular subtitle is known as the ‘‘COVID-Related Tax Relief Act of 2020’’). You should review this authority with your tax accountant to understand how it affects your particular tax situation.

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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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Start Thinking About PPP Loan Forgiveness

August 4, 2020 by 1 Comment

Many of ASA’s members obtained Paycheck Protection Program (PPP) Loans.  Now is the time to start thinking about what you need in order to obtain loan forgiveness, so you do not have to pay the loan back.

If you didn’t get the loan and you are eligible, then please apply now, before it is too late – you can find more details, here.

Forgiveness

One of the most attractive features of the PPP Loan program is that borrowers who spend the money on the intended expenses can get some or all of the loan forgiven.  The intended expenses are:

  • payroll
  • rent
  • mortgage interest and
  • utilities

But to secure forgiveness, you’ll need to submit the rights forms with the right supporting documentation.

See Our Video for More Guidance

ASA just finished a webinar on the process for obtaining loan forgiveness. It explains what forms need to be completed and provides tips on how to complete them.  It also details the supporting documentation that the government requires you to file in order to secure loan forgiveness.

The webinar is available on-demand, here.  Even if you haven’t yet hit the point of loan forgiveness, it is worthwhile to understand the requirements for loan forgiveness, so that you can take the right steps to maximize your forgiveness potential.

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Free Money Is Still Available (PPP)

August 3, 2020 by 2 Comments

If you haven’t yet applied for a Paycheck Protection Program (PPP) Loan, then there is still time.  The deadline for applying has been pushed back to August 8, 2020.

One of the most attractive features of the PPP Loan program is that borrowers who spend the money on the intended expenses can get some or all of the loan forgiven.  The intended expenses are:

  • payroll
  • rent
  • mortgage interest and
  • utilities

Forgiveness is also tied to retention of staff (headcount) and supporting payroll levels (retaining staff at 75% or more of their pre-Covid wages and hours).  Businesses that lose headcount may still be eligible for reduced forgiveness.

ASA compiled a list of Frequently Asked Questions on the PPP; the FAQ page includes information on eligibility.  If you are eligible but still have not yet applied, then please review the FAQ for more details and instructions.

ASA just finished a webinar on the process for obtaining loan forgiveness.  It is available on-demand, here.  Even if you haven’t yet hit the point of loan forgiveness, it is worthwhile to understand the requirements for loan forgiveness, so that you can take the right steps to maximize your forgiveness potential.

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Congress May Extend the Deadline for Forgivable PPP Loans

July 1, 2020 by Leave a comment

Did you miss out on filing for a Paycheck Protection Program (PPP) Loan?  The PPP program provides forgivable loans for small businesses.  The application period ended today, but there is still about 130 million dollars in the account that Congress set aside for the program.  With this money still untapped, The Senate passed a bill this evening (Tuesday) that would extend the application period for another five weeks.

This extension is not yet law!  It still needs to pass through the House and be signed by the President, and there is very little time for that to happen before the Independence Day recess.  Nonetheless, it looks like COngress wants to enact this extension.

Quick Answers

  • The PPP applies to small businesses, and to non-small businesses with less than 500 employees.  Not sure if you are small business?  You must meet a size standard.  Check out this table:
Business Activity NAICS (2017) Size Standard
Aircraft Parts Distribution 423860 500 employees
Aircraft Sales 441228 500 employees
Commercial Aircraft Leasing (dry lease) 532411 $35,000,000 annual revenue
Air Transportation Support Activities, including Repair Stations (but excepting “factory” conversion, overhaul and rebuilding) 488190 $35,000,000 annual revenue

UPDATE: Today, the House voted to extend the Paycheck Protection Program through Aug. 8.  Once signed by the president, this will reopen the application period for any company that did not previously file an application.

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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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Start Gathering Your Loan Forgivess Documentation, Now

May 22, 2020 by Leave a comment

Many of ASA’s members obtained Paycheck Protection Program (PPP) Loans.  The US Treasury Department has issued a loan forgiveness application, and even though it is likely too early to early to start applying today, you can still use this application as a guide to the sort of documentation you should be gathering and retaining  in support of your PPP loan forgiveness application.

Your bank may ask you to complete a slightly different form – with additional information that the bank desires – but this appears to be the form that will have to be submitted on your behalf to the SBA to obtain loan forgiveness (which involves the SBA reimbursing your bank for the loan.

The application includes the following simple calculation mechanism:

Forgiveness Amount Calculation: Payroll and Nonpayroll Costs

Line 1.Payroll Costs (enter the amount from PPP Schedule A, line 10):_____________________

Line 2.Business Mortgage Interest Payments: ____________________

Line 3.Business Rent or Lease Payments:_____________________

Line 4.Business Utility Payments:_____________________Adjustments for Full-Time Equivalency (FTE) and Salary/Hourly Wage Reductions

Line 5.Total Salary/Hourly Wage Reduction (enter the amount from PPP Schedule A, line 3): _____________________

Line 6.Add the amounts on lines 1, 2, 3, and 4, then subtract the amount entered in line 5:_____________________

Line 7.FTE Reduction Quotient (enter the number from PPP Schedule A, line 13): _____________________Potential Forgiveness Amounts

Line 8.Modified Total (multiply line 6 by line 7):_____________________

Line 9.PPP Loan Amount:_____________________

Line 10.Payroll Cost 75% Requirement (divide line 1 by 0.75): _____________________Forgiveness Amount

Line 11.Forgiveness Amount (enter the smallest of lines 8, 9, and 10):_____________________

The referenced “PPP schedule A” is a worksheet that is included as part of the application form.

Part of the criteria for loan forgiveness include retaining headcount.  The loan forgiveness is reduced by the percentage by which your headcount was reduced.  Companies have until June 30 to rehire workers to satisfy the headcount conditions.  But what if the workers do not want to come back?  The worksheets and their supporting calculations include “safe harbors” for borrowers who have

  1. made a good-faith, written offer to rehire workers, if that offer was rejected;
  2. fired employees for cause
  3. had employees who voluntarily resigned or requested reduced hours

If you had any of these events occur and you did not refill the position, then you can still count these as full time equivalents for employee headcount purposes under the loan forgiveness application.  If you did refill the position then you haven’t lost headcount in that position and there is no problem under the loan forgiveness-headcount rules!

You should plan on submitting certain documents in support of your loan forgiveness application:

  • PPP Loan Forgiveness Calculation Form
  • PPP Schedule A (from the application)
  • Payroll documentation to verify the payments for the covered period
    • Bank account statements or third-party payroll service provider reports documenting the amount of cash compensation paid to employees.
    • Tax forms (or equivalent third-party payroll service provider reports) for the periods that overlap with the Covered Period or the Alternative Payroll Covered Period:
      • Payroll tax filings reported, or that will be reported, to the IRS (typically, Form 941); and
      • State quarterly business and individual employee wage reporting and unemployment insurance tax filings reported, or that will be reported, to the relevant state
    • Payment receipts, cancelled checks, or account statements documenting the amount of any employer contributions to employee health insurance and retirement plans that the Borrower included in the forgiveness amount
  • Headcount: Documentation showing (your choice):
    • the average number of full time equivalent (FTE) employees on payroll per month between February 15, 2019 and June 30, 2019;
    • the average number of FTE employees on payroll per month between January 1, 2020 and February 29, 2020; or
    • there are additional rules for seasonal employers.
  • Nonpayroll: Documentation (1) verifying existence of the obligations/services prior to February 15, 2020 and (2) showing eligible payments from the Covered Period.
    • Business mortgage interest payments: Copy of lender amortization schedule and receipts or cancelled checks verifying eligible payments from the Covered Period; or lender account statements from February 2020 and the months of the Covered Period through one month after the end of the Covered Period verifying interest amounts and eligible payments.
    • Business rent or lease payments: Copy of current lease agreement and receipts or cancelled checks verifying eligible payments from the Covered Period; or lessor account statements from February 2020 and from the Covered Period through one month after the end of the Covered Period verifying eligible payments.
    • Business utility payments: Copy of invoices from February 2020 and those paid during the Covered Period and receipts, cancelled checks, or account statements verifying those eligible payments.

You will want to keep copies of all of the submitted documentation, and all of the non-submitted supporting documentation, for at least six years after loan forgiveness.  The terms of the loan forgiveness application state that all records relating to the Borrower’s PPP loan must be made available to authorized representatives of SBA, including representatives of its Office of Inspector General, upon request.

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IRS Thwarts Congress’ Efforts to Make PPP Loan Forgiveness Tax-Free

May 4, 2020 by 3 Comments

The IRS has published new guidance that makes Paycheck Protection Program (PPP) Loan Forgiveness less valuable (but it is still valuable).

Under ordinary circumstances, when a loan is forgiven, the debtor recognizes taxable income in the forgiven amount. So, if a debtor borrows $100,000 and the lender agrees that the loan does not need to be repaid, the lender typically gets a $100,000 deduction for bad debts and the debtor must declare income in the amount of the $100,000 forgiven (or “cancelled”) loan. For tax purposes, it is like the bank paid that money to the debtor.

Congress anticipated that the PPP would be forgiven if the payroll-related purposes of the PPP loan were met. The US government would reimburse the bank for the loan amount. Thus, the bank would not have an offsetting deductible loss associated with the cancellation of debt. To ensure that the debtor doesn’t need to pay extra taxes for this life-line, Congress explicitly stated in the CARES Act Loan Forgiveness provisions:

“For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.”

So far it all makes sense. Forgiven PPP loans become truly free money to those who receive them. And this fits the intended purpose, which is to bail out companies in a time of need. But recently, the IRS issued IRS Notice 2020-32 explaining how this provisions would be interpreted. And that is where the problems begin.

The IRS Notice explains that there is a law – 26 U.S.C. § 265 – that 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 offsetting payments that make the loan forgivable become nondeductible under section 265. In other words, the expenses that the forgiven loan is spent on becomes 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. Here is a simple example to illustrate the effect:

Example

Let’s say that a business has $1,000,000 in taxable income from normal operations in 2020. That business obtained a $100,000 PPP loan and used 100% of it on payroll. During 2020, the business paid total deductible wages of $600,000. Late in 2020 our hypothetical business applied for and received 100% loan forgiveness. To make this simple let’s assume that the business had $400,000 of other ordinary business expenses and no retained revenues.

If this had bean an ordinary loan that was forgiven, then the business would have an extra $100,000 income from the loan cancellation. Since it had $1,000,000 in taxable income from normal operations, $1,000,000 in ordinary business deductions, and an extra $100,000 income from the loan cancellation, it would pay 2020 taxes on $100,000 of income.

Because of the way that the IRS has interpreted the deduction issue under the Notice, when filing 2020 taxes, the business would exclude the $100,000 loan cancellation from income, but it would need to also exclude $100,000 of payroll from its deductions (because of section 265). Which means that the net result would be a payroll deduction of $500,000 instead of $600,000. The business would still be liable for taxes on $100,000 of income. This gets the business to the same tax result as if it had treated the loan forgiveness as income in the first place!

In some cases there may be a slight advantage to this approach (e.g. if the business has concerns about income caps or deduction caps) but for most businesses it simply unnecessarily complicates their tax filing, with little real change. Most importantly it frustrates the clear intent of Congress to prevent the loan forgiveness from being treated as taxable income.

There are ways to address this discrepancy. Many have talked about a legislative solution by which Congress would clarify that it did not intend to impose extra taxes on recipients of PPP loan forgiveness. If the IRS wanted to come up with a corrected notice, then the IRS could recognize that the language of the CARES Act excludes the forgiveness from income while the language of the section 265 talks about exemption from income (and could use this semantic difference to declare that section 265 does not apply in this particular situation).

To the extent that the PPP replaces lost revenues, on which a business would have paid taxes anyway, the IRS Notice puts businesses in a comparable situation to that they might have experience without Covid-19 (comparable – not the same). The business receives money and pays taxes on that money as income. The reason the IRS position is disappointing is because it is clear that Congress intended something different.

Even if this issue does not receive a legislative solution, PPP loan forgiveness is still a positive thing for those who are able to benefit from it.

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Paycheck Protection Program: Frequently Asked Questions

April 3, 2020 by 5 Comments

We’ve gotten a lot of questions about the Paycheck Protection Program. We will use this location to try to offer some answers for the ASA Community.  If you have questions that are not answered here, then please email them to Jason Dickstein and he will attempt to find answers and post them to the blog.

These answers are general in nature and are not meant to reflect legal advice.  Answers to your specific questions can turn on specific facts that apply to your situation.  Many of these issues can get far more complicated when you consider unusual fact patterns.  If you are uncertain about how the law applies to your particular facts, then you should contact an attorney for assistance.

Also, please note that SBA has JUST issued regulations for this program, which are available here.

 

Is my business eligible for the Paycheck Protection Program?

The Paycheck Protection Program. is meant for small businesses, and certain other businesses described in the CARES Act.  Under SBA rules, to be considered a small business you need to meet the SBA’s guidelines for your industry.

Industry small business thresholds are distinguished and published based on NAICS codes.  To identify the threshold that applies to you, you need to first identify the NAICS code that reflects your primary business activity.  In determining the primary industry in which a concern or a concern combined with its affiliates is engaged, SBA considers the distribution of receipts, employees and costs of doing business among the different industries in which business operations occurred for the most recently completed fiscal year. SBA may also consider other factors, such as the distribution of patents, contract awards, and assets.

For example, let’s imagine you are operating a repair station and also distributing aircraft parts.  The repair station accounts for 60% of your revenues, and it also accounts for 75% of your personnel.  Under this hypothetical, the repair station appears to be the predominant business for purposes of identifying the appropriate NAICS code to apply.

This table shows a few of the NAICS codes that commonly reflect the business models of ASA members:

Business Activity NAICS (2017) Size Standard
Aircraft Parts Distribution 423860 500 employees
Aircraft Sales 441228 500 employees
Commercial Aircraft Leasing (dry lease) 532411 $35,000,000 annual revenue
Air Transportation Support Activities, including Repair Stations (but excepting “factory” conversion, overhaul and rebuilding) 488190 $35,000,000 annual revenue

There are special rules for the Paycheck Protection Program. If your business does not meet the small business thresholds, but it has 500 employees or less, then it is permitted to apply for the Paycheck Protection Program (unless otherwise excluded).  For example, a repair station that has average receipts of $40 million would appear (at first blush) to be too large to qualify as a small business; but if it has only 400 employees then it likely is permitted to apply for the Paycheck Protection Program under this special rule.

This size standard includes the employees/revenue of your foreign and domestic affiliates (you have to consider affiliates, too, when calculating whether you meet the size standards).

There are exclusions, too.  They include those who are delinquent in paying a past SBA loan, and businesses with significant owners (>20%) who are in jail, under indictment, or otherwise subject to the criminal justice process.

Source 13 C.F.R. 121.107

 

How do I calculate revenue for size standard purposes?

For small business purposes you should use your most recent tax returns to identify your revenue.   If you are looking at your business tax return, this typically means your “total income” plus “cost of goods sold.”  You msut use the average of the most recent three years.  Where there are affiliates, you have to include the revenues of your affiliates.

Source 13 C.F.R. 121.104

 

How do I calculate number of employees for size standard purposes?

For small business purposes you should use the average number of employees (including those of your affiliates) in each pay period for the past 12 calendar months.

In determining your business’ number of employees, you should counts all individuals employed on a full-time, part-time, or other basis.  This includes employees obtained from a temporary employee agency.  Part-time employees are each counted the same as full-time employees (they are not fractions).  Volunteers are not considered employees (but for many companies in the ASA community, volunteers could violate the Fair Labor Standards Act so be careful about characterizing employees as volunteers).

Source 13 C.F.R. 121.106

 

What are the SBA Affiliation Rules and how do they impact my ability to qualify as a small business?

In determining whether a business is a small business, the SBA will add in the revenue/employees of its affiliates.  So if a business has three locations that are subject to common ownership or control, then the employees/revenues of all three locations will be aggregated to determine if the business is a small busieness.

Concerns and entities are affiliates of each other when one controls or has the power to control the other.  Two businesses may also be affiliates when a third party (or group) controls or has the power to control both.   It does not matter whether control is actually exercised, so long as the power to control exists.  Factors to consider in determining affiliation include ownership, management, previous relationships with or ties to another concern, and contractual relationships.  Negative control, like minority ownership with the power to prevent a quorum, can also be a form of control.

Foreign affiliates and non-profit affiliates are also considered affiliates for these purposes.

The Paycheck Protection Program created a special exception to the affiliation rule.  The exception applies to businesses under the NAICS codes beginning with 72 and having 500 or fewer employees at each location.  This includes hotels and restaurants.  This means that a hotel chain can treat each location as a separate business for purposes of applying the 500 person limit.

Source: CARES Act, 13 C.F.R. 121.103.

 

How do I apply for the Paycheck Protection Program?

Applications for the Paycheck Protection Program must be filed with a qualified bank or financial institution.  This includes lenders who are already qualified to process SBA section 7(a) loans.  You should consult with your local lender as to whether it is participating. You can visit the SBA website for a list of SBA lenders.

Source: Treasury PPP Fact Sheet for Borrowers

 

What is the Maximum Loan Size?

The maximum loan size is two and half times of your average monthly payroll for the prior year (so, 2.5 months-worth of payroll). If you’ve already received a disaster assistance loan between January 31, 2020 and the date on which these loans are made available, then you can also refinance that prior loan under this new program (this amounts to an increase in the maximum loan authority over the “2.5 times payroll” limit).

If you refinance an Economic Injury Disaster Loan (EIDL) through this mechanism, ten you should note that it will be subject to the limits of this loan program (e.g. two year term) as well as the benefits (e.g. lower interest rate)

There is an additional cap of $10,000,000 for the total loan amounts for which you may be eligible.

Source: CARES Act

 

What Can I Use the Loan For?

You can use the loan for

  • Payroll costs for US residents (which include compensation up to $100,000 annual salary)
  • Group health care costs and insurance premiums
  • Employee salaries and commissions
  • Mortgage interest (but not principal)
  • Rent
  • Utilities
  • Interest on pre-existing debt
  • refinancing an EIDL loan made between January 31, 2020 and the date on which the PPP loans become available

Only some of these uses are eligible for loan forgiveness.

The regulations anticipate that at least 75% of the PPP Loan must be used for payroll.

Source: CARES Act, SBA PPP Regulations

 

What qualifies as “payroll costs?”

The sort of payroll costs that are allowable expenses under the Program are compensation to U.S. employees (principal place of residence must be in the United States).  This compensation can take the form of:

  • salary, wages, commissions, or similar compensation
  • cash tips or the equivalent
  • payment for vacation, parental, family, medical, or sick leave
  • allowance for separation or dismissal (severance)
  • payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums, and retirement
  • payment of state and local taxes assessed on compensation of employees

This list does not include the provisions for sole-proprietors because ASA members tend to be structured as businesses.

Source: SBA PPP Regulations

 

How many employees do I have to retain qualify for the Paycheck Protection Program?

The Paycheck Protection Program does not specifically require you to retain any employees, but it is intended to allow you to retain employees, so failure to retain employees will (1) give you less payroll on which to spend the funds, and (2) reduce your ability to obtain loan forgiveness for the Paycheck Protection Program loan.

As part of the loan application, you will be required to certify “that funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments.”  But this does not mean that you can terminate all of the employees and spend all of the money on lease payments.  The regulations clarify that at least 75% of the loan must be spent on payroll.

The real penalty for failure to retain employees is that the amount of loan forgiveness is reduced if your headcount goes down or your payroll goes down (or if you fail to use the money for payroll).

Headcount Reduction: You compare the average monthly headcount during the eight weeks from the origination of the loan to the average monthly headcount during the period beginning on January 1, 2020 and ending on February 29, 2020. If headcount has gone down then you get a percentage of forgiveness correlative to the percent of remaining employees. For example, if you had 20 employees during the 2019 period, but only 18 during the eight weeks after origination of the loan, then you would only get 90% forgiveness (and the remaining ten percent of the loan would be subject to repayment).

Payroll Reduction: The amount of loan forgiveness is also reduced by the amount of any reduction in total salary or wages of any employee (except for employees who received more than $100,000 pay in 2019). This applies if the employee’s wages during the eight weeks after origination of the loan are reduced in excess of 25 percent of the total salary or wages of the employee during the most recent full quarter during which the employee was employed before the covered period. I think this clause may have been improperly drafted by the Senate, because we are comparing wages over an eight week period to wages over a thirteen week period; but it is clearly meant to be an incentive to continue wages at (or near) their pre-loan amounts.

In addition, not more than 25 percent of the loan forgiveness amount may be attributable to non-payroll costs.  So if you try to use the loan for rent and not payroll, you could severely limit your loan forgiveness options.

Source: CARES Act, SBA PPP Regulations

 

If I already applied for an SBA section 7(a) Loan then can I apply for a Paycheck Protection Program loan?

No.  Part of the certification necessary when you apply for the Paycheck Protection Program is a certification that you do not have an application pending for a loan under the same subsection (15 USC 636(a), or section 7(a) of the original Act), nor have you received a loan under that subsection, that would duplicate the purpose of the Paycheck Protection Program.

Thus, if you’ve already applied for a section 7(a) loan to cover things that reflect allowable expenses under the Paycheck Protection Program, then you will need to withdraw that application before you can apply for the Paycheck Protection Program.

This does not seem to apply to EIDL loans, because they arise under section 7(b) of the Act (a different subsection).

Source: CARES Act

 

If I already received an SBA Economic Injury Disaster Loan (EIDL) then can I apply for a Paycheck Protection Program loan?

Yes.  EIDLs appear to arise under subsection 7(b) so they do not appear to interfere with the PPP program.  If you received an SBA EIDL loan between January 31, 2020 and April 3, 2020, then you can apply for a PPP loan.

If your EIDL loan was not used for payroll costs, it does not affect your eligibility for a PPP loan.

If your EIDL loan was used for payroll costs, then your PPP loan must be used to refinance your EIDL loan.  The EIDL features an option for an advance of up to $10,000 that does not need to be repaid (“advance”).  Proceeds from such an advance up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan.

Source: CARES Act, SBA PPP Regulations

 

If I already received an SBA loan then can I apply for a Paycheck Protection Program loan?

It depends on the type of loan and it may depend on reasons why you got the loan.

Part of the certification necessary when you apply for the Paycheck Protection Program is a certification that you haven’t received a loan under the same subsection (subsection 7(a)), that would duplicate the purpose of the Paycheck Protection Program.  So if you received a subsection 7(a) loan and it was meant to be applied to payroll, mortgage, rent, or any of the other allowable costs of the Paycheck Protection Program, then you may be precluded from applying for the Paycheck Protection Program.

But you received an SBA 7(a) loan for something outside the allowable costs of the Paycheck Protection Program, then you may be permitted to apply for the Paycheck Protection Program.  The CARES Act specifies that if you already received a 7(a) loan between January 31, 2020 and the date on which the Paycheck Protection Program is made available, then you can apply for the Paycheck Protection Program loan as long as the EIDL was for a purpose other than the alowable uses for the Paycheck Protection Program.  As an example, if you were in a declared disaster zone due to a tornado and received an EIDL to pay for tornado-damage to your facility, then that would not inhibit your efforts to secure a Paycheck Protection Program loan.

Source: CARES Act

 

What is the PPP Loan Interest Rate?

1%

The statute explained that interest will be charged in an amount set by SBA, not to exceed 4 percent.  SBA had revealed a plan to set the interest rate at 0.5%, but the final regulation set interest at one percent.

Source: CARES Act, SBA PPP Regulations

When Do I Start Repaying the PPP Loan?  What is the term?

Under the statute, repayment is deferred for between 6 months and one year, and the repayment period can be up to ten years.  The US Government guidance that has been released since the Act was passed states that the loans will be for only two years and the deferment period will be six months. This means that you will start repaying the loan six months after it was issued.

Interest will continue to accrue on PPP loans during this six-month deferment.

Only the amount remaining after loan forgiveness needs to be repaid.  This may be limited to interest if the principle is entirely forgiven.

Source: CARES Act, Treasury PPP Fact Sheet for Borrowers, SBA PPP Regulations

 

Do I Have to Repay the PPP Loan?

Not if you spend it on the right things and meet the right requirements! You can receive loan forgiveness for amounts spent, during the eight weeks after origination of the loan, on:

  • Payroll
  • Mortgage interest
  • Rent
  • Utilities

Note that this is a slightly shorter list than the list of things for which you can use the loan, so you can use the loan as a typical loan for the other eligible expenses, as well.  Money spent on allowable purposes outside this list will continue to be treated as a non-forgiven loan.

Source: CARES Act

 

How Much Loan Forgiveness Can I Get?

You can get up to 100% of the principle forgiven, as long as it is used for Payroll, Mortgage interest, Rent, and/or Utilities.  However, there are certain things that can reduce this amount.  The amount of loan forgiveness will also be reduced if your headcount goes down or if your payroll is substantially reduced:

Headcount Reduction: You compare the average monthly headcount during the eight weeks from the origination of the loan to the average monthly headcount during the period beginning on January 1, 2020 and ending on February 29, 2020. If headcount has gone down then you get a percentage of forgiveness correlative to the percent of remaining employees. For example, if you had 20 employees during the 2019 period, but only 18 during the eight weeks after origination of the loan, then you would only get 90% forgiveness (and the remaining ten percent of the loan would be subject to repayment).

Payroll Reduction: The amount of loan forgiveness is also reduced by the amount of any reduction in total salary or wages of any employee (except for employees who received more than $100,000 pay in 2019). This applies if the employee’s wages during the eight weeks after origination of the loan are reduced in excess of 25 percent of the total salary or wages of the employee during the most recent full quarter during which the employee was employed before the covered period. I think this clause may have been improperly drafted by the Senate, because we are comparing wages over an eight week period to wages over a thirteen week period; but it is clearly meant to be an incentive to continue wages at (or near) their pre-loan amounts.

To get loan forgiveness, you will have to submit an application to the lender the proves what you spent the money on, so keep good records.

Source: CARES Act

What if I have already terminated employees before I realized that I could get the PPP?

If I have already terminated workers before the PPP, then you may be able to secure the full amount of loan forgiveness by rehiring them.

If you reduced headcount and/or salaries between February 15, 2020 and April 26, 2020, but you remedied headcount/salaries by eliminating the reduction in employees/salary by June 30, 2020, then the loan forgiveness will be calculated without any reduction.

Source: CARES Act

 

Is it easier to apply for the PPP than for other SBA programs?

Yes.  Some of the normal small business loan preconditions are waived for these Paycheck Protection Program loans. The most important ones are:

Source: CARES Act

 

If I seek loan forgiveness, then is the forgiveness treated as taxable income?

The amount forgiven will be treated as cancelled debt but is NOT included in gross income.

Typically, some cancelled debt is considered taxable income under federal tax standards.  But another clause in the CARES Act would exclude this forgiveness amount from gross income so this may mitigate subsequent tax consequences.

Source: CARES Act

 

What happens if PPP loan funds are misused?

If you use PPP funds for unauthorized purposes, then SBA will direct you to repay those amounts.

If you knowingly use the funds for unauthorized purposes, then you may be subject to additional penalties through mechanisms such as government fraud charges.

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Payroll Protection Program Application Has Been Released

March 31, 2020 by Leave a comment

The Administration promised to get money out to the small businesses fast, and they are doing what they can to make good on that promise.  The Treasury Department has posted a press release describing some of the term and conditions for the Payroll Protection Program (PPP).  Some of the new details include the terms and conditions for all PPP loans:

  • Interest rate of 0.5% (even better than the “not more than 4%” promised in the statute)
  • Maturity of 2 years
  • First payment deferred for six months
  • 100% guarantee by SBA
  • No collateral
  • No personal guarantees
  • No borrower or lender fees payable to SBA

The maximum value of these loans is 2.5 times the monthly average of your past year’s worth of payroll.  Remember, these are the loans that can be forgiven, as long as you meet the PPP requirements, like employee retention and use for approved purposes (like payroll and rent).

Other resources that have been made available today include:

Be sure to keep the Fact Sheet for Lenders handy when you contact your bank.  I joined the virtual town hall with Senator Cardin and Congressman Raskin this evening, and one man explained that his bank was quoting these loans as if they were traditional EIDL loans (which have additional requirements), and was quoting an expected lead time on the loan of months.  The US Government expectation on these loans is that they will be processed by your banks in a matter of days.

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