Paycheck Protection Program and Loan Forgiveness

Low interest loans available through the Paycheck Protection Program (PPP) provision of the Coronavirus Aid, Relief and Economic Security Act (the CARES act) are meant to help employers keep employees on the payrolls, and while there are many positives, be aware, before it drops, of the other loan-related shoe.

A great many employers and businesses have taken, (or will take) advantage of these loans, issued by the Small Business Administration. Among the information on the page: how to determine if you’re eligible, your potential loan amount, and how to apply.

These loans are potentially eligible for tax-free forgiveness if businesses follow SBA’s rules.

The problem: The rules for forgiveness either don’t yet exist or seem to continuously change. Nevertheless, what we know – today – is that in some situations a portion of a loan may not be forgiven.

To obtain full forgiveness, businesses must use at least 75% of their loan for allowable payroll costs during the eight-week period following loan origination; the remainder must be used for rent, utilities, and interest from eligible loans.

Allowable payroll costs include wages, salaries, and tips up to $15,385 per employee; eligible owner compensation - up to eight weeks’ worth of the $100,000 annual maximum allowable compensation; health care expenses; retirement contributions; and state taxes on employee payroll, such as unemployment insurance premiums.

Eligible interest expense includes interest from loans secured by the business’s real and personal property if the loans were obtained before Feb. 15, 2020. This applies if the interest expense can be included on the applicable business income tax form or return, including Schedule C, and forms 1065, 1120 series, and 990. Likewise, eligible rent payments must arise from eligible leases that were incurred prior to Feb. 15, 2020.

Additionally, for a business to obtain maximum PPP forgiveness. its full-time employee headcount must be restored to pre-COVID 19 levels by June 30, 2020. The pre-COVID-19 headcount is based on the average monthly number for the same period in 2019, or from the average of certain interim periods.

Though the SBA hasn’t yet issued guidance on how fewer employees or smaller payrolls will reduce the forgiveness-eligible amount, many accounting and law firms are offering interpretations online.

One such interpretation, for example, involves year-to-year employee retention ratios. For example, if during the eight-week period after receiving the PPP loan, the company’s average number of full-time equivalent (FTE) employees shows less than a 1.0 ratio to the company’s FTEs during the same eight-week period in 2019, then the loan forgiveness amount must be reduced by multiplying the ratio computed above multiplied by the amount that is otherwise eligible for forgiveness.

Got that?

Another limitation comes into play if the average payroll drops by more than 25% in similar time periods as those described above. However, please understand that such interpretations are tentative, and could change depending on the latest SBA directives. And we are not certain the order in which these limitations are applied.

The US Tax Code contains a provision that generally prohibits any deduction for expenses related to production of tax-exempt income. A forgiven PPP loan would be technically be tax-exempt income. This week the IRS issued Notice 2020-32, in which it confirmed its position that the expenses used to obtain PPP forgiveness will not be deductible when businesses obtain loan forgiveness. The notice effectively makes forgiven PPP loan proceeds a pass-through from the government to employees, with no tax impact to the business. However, businesses would still be on the hook for the employer’s share of federal payroll taxes from wages used to obtain PPP forgiveness, and those payroll taxes should be fully deductible.

Money is never “free.” Someone is paying, or will pay, somewhere, somehow. Stay tuned to the latest developments, for your, and your paycheck’s, protection.


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Tagged COVID-19