The law and rules governing the PPP have been updated since this article was originally published. Please see our two-part series, PPP revisited, based on current legislation and guidance.
A widely popular lifeline for many small businesses, the Paycheck Protection Program (PPP) was enacted in the Coronavirus Aid, Relief, and Economic Security (CARES) Act and replenished three weeks later in “Stimulus 3.5.” The recently passed Paycheck Protection Program Flexibility Act of 2020 (Flexibility Act) made additional changes to the program. With the principal purpose being to help employers retain their employees on the payroll, these loans are designed to now cover payroll and related expenses paid or incurred during a maximum 24-week period (recently updated from an eight-week period) that follows the date the loan proceeds are received, or from that date through Dec. 31, 2020, whichever period is shorter. Primarily, small business employers with 500 or fewer employees (affiliation rules apply) qualify for the loan program. Individuals qualifying as sole proprietors as well as independent contractors can also participate.
The PPP’s loan forgiveness component likely is the favorite feature of the program. If at least 60% of the loan proceeds are used to fund payroll expenses (with up to 40% going solely toward paying covered rent obligations, covered utility payments or interest on covered mortgage obligations), the borrower may be eligible for full forgiveness of the PPP loan. A prorated forgiveness formula is available for borrowers who do not meet the requirements for a full forgiveness of the PPP loan. It is this forgiveness feature that raises numerous tax questions.
In general, loan forgiveness results in taxable income. When loan forgiveness escapes taxation through one of a limited number of exceptions, the cost is a reduction of certain tax attributes (net operating losses, depreciable basis, etc.) belonging to the loan recipient. Regarding PPP loans, the CARES Act stipulates any PPP debt forgiveness is to be excluded from gross income. However, there is no requirement to reduce tax attributes.
Unfortunately, in a blow to taxpayers, the IRS recently released guidance indicating expenses paid using forgiven PPP loan proceeds would not be deductible. So, while the forgiven loan proceeds are not taxable, the expenses paid with those same proceeds are not deductible. Congress proposed bipartisan legislation in May to allow deductibility of permissible PPP expenses even when the associated loan proceeds are forgiven. Members of both the Senate and the House of Representatives have publicly said the current IRS guidance does not reflect congressional intent. To date, this legislation has not passed, though it may ultimately be attached to a larger stimulus or tax package.
In the meantime, the Small Business Administration (SBA) released, and subsequently updated for changes made by the Flexibility Act, the PPP loan forgiveness application along with instructions. While simple on its face — the entire package is only 12 pages — the application requires a lot of supporting data. For example, to substantiate eligible expenses, payroll records should include the number of full-time and part-time employees, payroll frequency (weekly, bi-weekly, semi-monthly, monthly, etc.), salary and leave benefits per person as well as healthcare and retirement benefits on a per-employee basis. Keep in mind, salary and wages are capped at $100,000 per employee on an annualized basis. In addition, copies of payroll tax returns, benefit plan payment invoices, and bank, mortgage interest, rent and utility statements should be retained for at least six years and made available to the lender when requested.
Recently, the SBA published a shorter version of the application, which can be used by borrowers who did not have employees at the time they applied for their loan, or did not reduce their employment levels or employees’ pay during the covered period. Borrowers who did reduce their employment levels but can attest that they were unable to operate at pre-COVID-19 levels (due to compliance with government health and safety guidelines) are also eligible to use the streamlined form.
Self-employed individuals are eligible for PPP loan forgiveness using a formula taking either:
This limit applies in total across all of the individual’s businesses. In other words, if an individual operates multiple businesses and files a separate Schedule C for each, the maximum loan forgiveness amount for the individual is $20,833.
For employers, the maximum amount of cash compensation eligible for forgiveness is generally limited to $46,154 per employee over the 24-week covered period in 2020 (note this maximum amount would be smaller for borrowers whose covered periods end on Dec. 31, 2020, short of 24 weeks). However, there is an additional limit on amounts paid to owner-employees or general partners, being the lesser of $20,833 or two and a half months of total 2019 compensation across all related businesses. This could further restrict the amount of owner compensation eligible for forgiveness for many taxpayers. Unfortunately, owner-employee is not formally defined, but the updated forgiveness application does refer to “owner employees of an S-corporation”. Finally, it is unclear whether other individuals would fall under this definition, if attribution rules apply, or how related-party salaries are combined when calculating the limitation.
Separate and distinct from the PPP, the EIDL is a long-running program. Designed to help businesses, renters and homeowners located in federally declared disaster regions, the CARES Act expanded the EIDL to assist taxpayers during this COVID-19 pandemic. Taxpayers that have suffered an economic hardship due to the pandemic are eligible if they meet certain requirements:
Sole proprietors, independent contractors, most private not-for-profit organizations, cooperatives and tribal small businesses are included as businesses eligible to participate.
Due to funding limitations and the volume of submitted applications, the SBA initially restricted this program to U.S. agricultural businesses. Effective June 15, 2020, the EIDL loan program was expanded to allow more businesses and not-for-profit organizations to apply.
The CARES Act relaxed the normal EIDL rules, resulting in the following parameters:
The CARES Act also authorized a $10,000 Emergency EIDL grant that can be used to pay sick leave, payroll, rent and mortgage payments. While the Emergency EIDL grant does not have to be repaid, it does reduce the amount of PPP loan forgiveness.
The employee retention credit (ERC) is a fully refundable tax credit equal to 50% of qualified wages. Applying to wages paid between March 13, 2020, and Dec. 31, 2020, eligible employers can receive up to a $5,000 maximum credit per employee (based on $10,000 of qualified wages, including qualified health plan expenses). Keep in mind, wages and related payroll taxes constituting the credit cannot also be deducted as compensation expense.
Further, the ERC is not available for wages for which the employer received a credit for paid sick or family leave under the Families First Coronavirus Response Act. In addition, wages paid to certain family members, including children, parents, aunts, uncles, among others, are not eligible for the credit.
Eligible employers are those that have had business operations partially or completely shut down by government order. Otherwise known as the suspension test, qualified wages are those paid solely during the shutdown. In addition, employers can also qualify for the ERC if gross receipts for the calendar quarter in 2020 are less than 50% of gross receipts for the same calendar quarter in 2019 (gross receipts test). On the other hand, employers deemed essential, but still have a significant loss in revenue due to their customers being shut down or having to shelter in place could potentially qualify for the ERC if facts and circumstances fit the requirements.
Employers that have also borrowed using the PPP should not request advance payment of the ERC via Form 7200 (Advance Payment of Employer Credits Due to COVID-19). Currently, it is unclear whether employers can even use the ERC for periods prior to borrowing if participating in the PPP. As a result, we recommend affected employers file Form 7200 with their quarterly payroll return (Form 941).
Finally, while the aggregation rules do apply to a controlled group of employers or to separate divisions, it is unclear how the suspension test would be applied if the group members operated different trades or businesses. For example, consider a brother-sister controlled group, one entity operates a restaurant and meets the suspension test while the other is a farming enterprise and does not. In this situation, it is unknown whether the entities would both be ineligible for the ERC or treated separately. We recommend each separate trade or business be evaluated individually to apply the suspension test.
View more insights from our guide to tax planning during and after COVID-19
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.