The US government’s response to COVID -19 included massive stimulus funding along with cumbersome and rushed guidance that confused even the most conscientious business owner. With another round of stimulus on the table, businesses that accepted Paycheck Protection Program (PPP) money in 2020 should look to the definitive guidance published December 2020 to confirm compliance standards and new tax benefits.
Let’s review before explaining the recent changes.
As part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act signed into law on March 27, 2020, over $600 million was earmarked for PPP loans. The loans included potential forgiveness and a remarkably low interest of 1% without collateral. A business had to meet certain criteria ensuring that funds were targeting small businesses in need. Generally speaking, funds helped subsidize payroll at businesses with less than 500 employees, and no access to other capital.
Eligible borrowers could receive up to 250% of their average monthly payroll expenses for a year before the date of the loan, capped at $10 million. To obtain forgiveness, borrowers had to spend the loan proceeds on qualified expenses such as payroll (capped at $100K per employee), employee benefits, interest on certain mortgage obligations, and rent. The amount of forgiveness was reduced if the employer decreased its headcount or payroll.
In 2020, the Internal Revenue Service (IRS) and Small Business Administration (SBA) released sporadic guidance which often created as many questions as it did answers. Fortunately, in late December, the Consolidated Appropriations Act (CAA) was signed into law providing long-awaited, detailed guidance for both tax and accounting purposes.
Borrowers must now certify under penalty of perjury “current economic uncertainty makes a loan request necessary to support the ongoing operations”. The SBA requires a company to determine its ability to independently support operations from other sources including access to public markets or other private funding sources.
Tax & Accounting Impact
From the beginning, accounting professionals and their clients questioned if and when debt forgiveness would be considered income. Would it happen automatically without action by the borrower or would the SBA have to confirm that all requirements had been met? Questions also persisted regarding whether an eligible business was able to deduct expenses using PPP funding.
Based on early guidance, such expenses were not deductible. However, in a dramatic and welcomed development, the new CAA law and related guidance from the Treasury Department and IRS allowed eligible expenses to be deductible, thus creating a double benefit for taxpayers. The first benefit is that income otherwise recognized as forgiven debt is excluded from gross income for income tax purposes under Section 1106(i) of the CARES Act. The second is the ability to deduct expenses paid by PPP funds.
From an accounting perspective, generally, PPP loans are recorded under the guidance of ASC 470 as a debt in which the extinguishment only happens when paid, released by court mandates, or actual forgiveness from the creditor under ASC405-20.. As such, the PPP loan (and related recorded interest) is only reversed when the company receives formal notification of forgiveness from the SBA. The offset is recorded as a gain on extinguishment of debt.
Traps and Pitfalls
Beware that the guidance described herein pertains to Federal taxes only. If you are operating in different states, you should discuss how states are classifying government assistance with your tax advisor immediately. Calculations made forstate income tax purposes may not be the same as those for Federal. Some states may not consider loans as forgiven debt or may treat payroll as a taxable expense. Newcomers to Florida should be especially aware of the differences between Florida and other statutory rules when it comes to PPP loans and other programs.
It is also important that PPP expenses are recorded separately from other expenses for proper classification by your tax advisor. Tracking the timing of the expenses matters as well. If the debt forgiveness and related expenses do not occur in the same period, you could misrepresent your assets and liabilities. Proper recording and classification of PPP funds improve your calculations and maximize your tax benefits.
Care should be taken by management to not remove the liability from the balance sheet at some time earlier than the SBA (the creditor) forgiveness. A common issue where management removes the PPP loan when it is informed by the bank that all criteria have been met for forgiveness. Such an early removal is contrary to the guidance provided by ASC 405-20. Also, in cases where the borrower treats the proceeds as a grant, the borrower may incur additional deferred taxes from an ASC 740 (tax provision) perspective. Be sure to contact Daszkal Bolton to ascertain the appropriate treatment and timing for income tax reporting purposes.
Daszkal Bolton’s dedicated PPP team of tax, audit, and accounting professionals includes specialists with expertise in accounting for income taxes, corporate tax matters, accounting methods, and tax consulting including tax provision implementation, ASC 740 (FAS 109) preparation and review, Uncertain Tax Position (FIN 48) preparation and review. Firm members have handled similar uncertain and evolving tax changes in the past and know how to calculate various implementation scenarios then pivot quickly with new guidance to ensure clients are well-positioned to receive the greatest tax benefit possible.
Andres Molgora is a Tax Director in the Boca Raton office. He is a tax professional with more than 11 years of experience in public accounting, including 9 years with a national firm.