What You Need to Know About Payroll Protection Plan Loan Forgiveness
As clients have begun to receive their Payroll Protection Plan Loans (PPP Loans), the next focus is on what they will need to do to prepare for making an application to their lender for forgiveness of the loan. Applications for forgiveness should be filed as soon as possible at the end of the 8-week period with the lender. The lender and SBA then have 60 days to rule on your forgiveness application. While additional guidance is expected to be released by the SBA related to loan forgiveness on the many open questions that remain (hopefully sooner rather than later), clients need to begin to plan based on the guidance that is currently available in order to be able to adopt quickly when this additional guidance is published.
- a. “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
- b. “The funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments; I understand that if the funds are knowingly used for unauthorized purposes, the federal government may pursue criminal fraud charges.”
- i. On April 23, 2020 the SBA published additional guidance that “Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.”
- ii. Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 14, 2020 will be deemed by SBA to have made the required certification in good faith. The SBA intends to provide additional guidance on how it will review the economic uncertainty certification before May 14, 2020, so borrowers that are still unsure about whether to return the funds may wish to await this additional guidance before doing so.
- iii. An employer that applied for a PPP loan, received payment, and repays the loan by the safe harbor deadline (May 14, 2020), will be treated as though the employer had not received a covered loan under the PPP for purposes of the Employee Retention Credit. Therefore, the employer will be eligible for the credit if the employer is otherwise an eligible employer for purposes of the credit. This credit is 50% of wages (wages defined a gross payroll plus employer provided health care [insurance]) paid up to $10,000 of wages (total credit up to $5,000) for wages paid after March 12, 2020 and before January 1, 2021. The credit will serve to reduce federal payroll tax deposits and to the extent it exceeds the deposit will carry to the next pay period and could be refundable either by filing Form 7200 or with the filing of the second quarter (and subsequent quarters) Form 941.
- c. A further certification outlines the penalties for false statements and certifications, “I further certify that the information provided in this application and the information provided in all supporting documents and forms is true and accurate. I realize that knowingly making a false statement to obtain a guaranteed loan from SBA is punishable under the law, including under 18 USC 1001 and 3571 by imprisonment of not more than five years and/or a fine of up to $250,000; under 15 USC 645 by imprisonment of not more than two years and/or a fine of not more than $5,000; and, if submitted to a federally insured institution, under 18 USC 1014 by imprisonment of not more than thirty years and/or a fine of not more than $1,000,000.
- d. Borrowers should reevaluate their initial certifications and the need for the funds and consider if it is appropriate to return the loan or withdraw the loan application.
2. The tax implications of loan forgiveness:
- a. The CARES Act provides that as long as loan proceeds are spent appropriately (more on this to follow) all or some portion of the loan will be forgiven, and this debt forgiveness will not be included in income. In essence taxpayers anticipated they could receive the benefit of the deductions with no corresponding income on the loan forgiveness, a win, win for the taxpayer.
- b. On April 30,2020 the IRS summarized its position in Notice 2020-32, “this notice clarifies that no deduction is allowed for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP loan and the income associated with the forgiveness is excluded from gross income”. The IRS position does not surprise us, as it is consistent with prior rulings and case law. However, we believe that was not the original intent for several reasons:
- i. The language on debt forgiveness being nontaxable would not have been needed in the law because you would get to the same result; if forgiveness was included in income but you could deduct the expenses, is the same as forgiveness is not included in income but expenses are not deductible. So why bother with the language on the exclusion of forgiveness from income included in the original law? Because,
- ii. After the IRS Notice was published, the head of the Senate Finance Committee and the House Ways and Means Committee both said that was not the original intent of the law (these are the Committees that write the tax laws). In other words, legislative action is required and expected although you don’t know what will happen if a change has to go up for vote.
- c. So businesses need to plan for a neutral tax outcome on loan forgiveness (no income on forgiveness but no deductions either) and anticipate corrective legislation that will give them the additional deductions with no corresponding income.
3. What do businesses need to do now:
- a. Know your eight-week period (covered period) from the date the loan was funded, not closed, and the qualifying expenses you will incur during this period.
- b. Start a schedule and accumulate payroll registers, cancelled checks and/or check registers, bank statements, paid invoices, and other evidence of payment for:
- i. Payroll costs during the covered period which include:
- 1. Gross payroll capped at a $100,000 annual salary ($15,384.62 total during the covered period) and excluding payments to employees whose residence is outside the United States. Also excluded is qualified sick leave and family leave wages for which a credit is allowed under the Family First Coronavirus Response Act.
- 2. Employer cost of medical insurance (net of employee contribution)
- 3. Employer pension costs
- 4. Employer cost of state and local taxes assessed on compensation (state unemployment, disability and family leave assessments)
- ii. Interest on mortgage debt and business loans where the loan obligation was incurred before February 15, 2020.
- iii. Rent obligations under lease agreements in force before February 15, 2020.
- iv. Utilities where serviced commenced prior to February 15, 2020 including electricity, gas, water, transportation, telephone, internet.
- v. Refinancing an SBA EIDL loan made from January 31, 2020 through April 3, 2020.
- i. Payroll costs during the covered period which include:
Note: One major uncertainty that we are awaiting guidance on is whether forgivable costs need to be “incurred, “paid”, or both during the covered period. There is often a timing difference between when an expense is incurred and paid. If the interpretation is to include only expenses incurred and paid, then borrowers should plan to make final expense payments on the last day of the eight-week period or they will suffer a reduction in forgiveness and have to repay parts of the loan for which forgiveness was expected. If the interpretation is to include expenses incurred or paid during the eight-week period, then we expect there might be some exceptions to exclude previously-accrued or prepaid items from forgiveness.
- c. Compute your full time equivalent employees during the covered period and the two look back periods, February 15, 2019 to June 30, 2019 and January 1, 2020 to February 29, 2020 in order to understand the affect on computing loan forgiveness, see the next section.
4. What do sole proprietors and independent contractors need to do now:
- a. Generally they will follow the outline in 3. above for businesses with a few exceptions based on SBA Interim Final Rule issued on 4/14/2020:
- i. Payroll costs for “gross payroll” for the sole proprietor or independent contractor will be based on 8/52 of their 2019 mfor Sch C capped at the same $100,000. Payroll costs for employees are computed the same as 3. above.
- ii. For all other expenses, “You must have claimed or be entitled to claim a deduction for such expenses on your 2019 Form 1040 Schedule C for them to be a permissible use during the eight-week period following the first disbursement of the loan (the “covered period”). For example, if you did not claim or are not entitled to claim utilities expenses on your 2019 Form 1040 Schedule C, you cannot use the proceeds for utilities during the covered period.”
- a. Forgiveness can be up to the original loan plus accrued interest (at 1%) to the extent of these qualifying expenses. However, not more than 25% of the loan forgiveness can be attributable to non-payroll costs. SBA will be issuing additional guidance on loan forgiveness.
- b. There can be a further reduction in forgiveness if there is a reduction in the number of employees during the covered period (vs two lookback periods) or a reduction in an employee’s salary of greater than 25% (if they did not earn during any pay period in 2019 wages at an annualized rate of more than $100,000 or $1,923 per week).
- i. For each pay period during the covered period you must compute your full time equivalent (FTE) employees and convert it to a monthly average.
- ii. Employers must compile their payroll registers and compute their FTE for each pay period and the monthly average of FTE for each of the following lookback periods, February 15, 2019 to June 30, 2019 and January 1, 2020 to February 29, 2020.
- iii. Payroll costs to be forgiven during the covered period will be:
- 1. Payroll costs during the covered period times a fraction of, average FTE during the covered period over average FTE during one of the lookback periods (employers can pick the lookback period that gives them the maximum forgiveness).
- 2. This will be further reduced to the extent any employee that did not make an annualized salary of $100,000 in 2019 has a reduction in salary greater than 25% compared to their most recent full quarter (3/31/20 or if not a full quarter 12/31/19).
- iv. Any reduction in FTEs that occurred between February 15, 2020 and April 26, 2020 to at least the number of FTEs employed on February 15, 2020, and any reduction in salary or wages for each employee compared to February 15, 2020, shall not reduce the amount of loan forgiveness if the borrower eliminates the reduction in employees or reduction in wages by June 30, 2020. If an employee does not accept a rehire offer on comparable terms during the cure period, there will not be a reduction in forgiveness. Any replacement of employees by other employees (in the same quantity), will not impact forgiveness.
Borrowers need take the necessary steps to, (i) reevaluate and document the necessity of the PPP Loan for their business, (ii) understand the tax consequences of loan forgiveness and deductions, (iii) schedule out and accumulate documentation of the qualified expenditures that they will incur during the covered period and (iv) model the amount of expected loan forgiveness based on (a) no more than 25% of expenditure on non-payroll costs, (b) reduction in FTE and (c) reduction in wages. Borrowers can then plan and document how to spend the loan proceeds and bring back employees and restore wages in order to achieve maximum loan forgiveness.
Reach out to us if you have any questions or require any assistance in these matters.