The SBA has come out with SOME guidance on the key issues that will determine the amount of loan forgiveness that a company will earn.
Note that, while many questions are now answered, several questions are yet to be clarified.
May 1, 2020 UPDATE: Today the IRS has issued guidance clarifying the treatment of PPP loan forgiveness income and the deductibility of expenses paid with the proceeds of a PPP loan received under the CARES Act.
For federal tax purposes, the IRS has stated that the amount of a PPP loan that is forgiven in accordance with the terms of the CARES Act will be excluded from taxable gross income. While this treatment has been expected, just today the IRS has clarified that otherwise deductible expenses incurred that result in loan forgiveness (the generation of non-taxable gross income) will not be deductible for federal income tax purposes.
Specifically, the IRS has stated 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.
This is a logical conclusion because it eliminates the double tax benefit that would result from (1) excluding PPP forgiveness from taxable gross income and (2) taking deductions for expenses paid with the non-taxable income.
What we know so far…
Companies that have received funding under the PPP will have an 8-week period to use the PPP funds for eligible expenses. The 8 weeks begin on the date the lender makes the first disbursement of the loan.
It will be critically important that you keep detailed records regarding the use of the PPP proceeds loan during the 8-week period.
We highly recommend that you start keeping detailed records beginning the day that that the PPP proceeds are deposited in your account. While it is not a requirement, we recommend that PPP loan proceeds be deposited into a separate bank account, with only costs eligible for loan forgiveness paid out of that account. Spending the PPP proceeds on eligible costs and good recordkeeping will be the determining factor in maximizing your loan forgiveness.
Eligible costs incurred and payments made for loan forgiveness include:
- Certain payroll costs.
- Interest payments on a mortgage incurred in the ordinary course of business on real or personal property and that was in existence on Feb. 15, 2020.
- Rent payments under leasing agreements in existence on Feb. 15, 2020.
- Utility payments for electricity, gas, water, transportation, telephone or internet for which service was in existence on Feb. 15, 2020.
The actual amount of loan forgiveness will be determined based on eligible costs incurred and payments made during the 8-week period.
Payments for payroll costs are the primary eligible cost for forgiveness under the PPP. Payroll is broadly interpreted. However, care must be taken as not all payroll related costs are eligible for loan forgiveness.
Payroll costs that are eligible for loan forgiveness include:
- Salary, wages, commission or similar compensation
- Payments for vacation, parental, family, medical or sick leave
- Certain termination or separation costs
- Group health care benefits, including insurance premiums
- Retirement benefits
- State or local payroll taxes
Payroll costs that are not eligible for loan forgiveness:
- Payments to an independent contractor (they can apply individually).
- Cash compensation in excess of $100,000.
- The employer’s share of federal payroll taxes.
- Qualified sick leave and qualified parental leave wages for which credit is allowed under the Families First Coronavirus Response Act (FFCRA)
There are some limitations:
- No more than 25 percent of the loan forgiveness amount can be attributable to non-payroll costs (i.e., mortgage interest, rent and utilities)
- If you received proceeds from an Economic Injury Disaster Loan (EIDL), any advance up to $10,000 will be deducted from the loan forgiveness amount.
- Finally, the loan forgiveness amount will be reduced if the business has reduced its number of full-time equivalent (FTE) employees or has reduced the salary or wages of certain employees based on a formula that calculates a decline (if any) in the number of FTE employees or wages.
- Reductions in the number of FTE employees, or reductions in salary or wages, that occurred between Feb. 15, 2020, and April 26, 2020, will not reduce the loan forgiveness amount if, by June 30, 2020, the borrower eliminates the reductions.
How is loan forgiveness earned?
To earn loan forgiveness, a borrower must apply to their lender and include certain documentation in the application as follows:
- Verification of the number of FTE employees on the payroll and pay rates for the covered period and the prior periods included in the formulas for determining any reduction in loan forgiveness, including payroll tax filings reported to the Internal Revenue Service and state income, payroll and unemployment insurance filings
- Cancelled checks, payment receipts, transcripts of accounts or other documents verifying payments on mortgage obligations, rent payments and utility payments
- A formal representation that the documentation is true and correct and that the amount for which forgiveness is requested was used to retain employees, make interest payments on an eligible mortgage obligation, make payments on a covered rent obligation or make utility payments
What remains to be resolved…
The remaining issues to be answered are more technical in nature. Definition of some of the terms in the CARES Act are unknown. For example:
- Many businesses may be closed at the time their loan is funded due to stay at home orders. Will the covered period be modified or extended?
- The phrase “costs incurred, and payments made” is undefined.
- How are FTE employees determined in light of furloughs, layoffs and reduced schedules? How do seasonal employees factor into the formula?
- Rent is undefined (does it include CAM’s). Is related party rent eligible? Are insurance and taxes included as lease payments eligible?
These and other questions are to be determined over the coming days.