It’s been a while since we looked at the Paycheck Protection Program (PPP) and its loan forgiveness feature. Since the beginning of the program in April it has undergone some revision, many questions have been answered, and yet the answers to some questions remain unclear. Currently there is much discussion of when to file the application for loan forgiveness, with renewed concern about the taxation aspects of the PPP.
As a loan, the PPP funds are recorded on the practice’s balance sheet as a liability when they are received. Once the loan is forgiven, the amount of forgiveness becomes income, and any remaining unforgiven amount continues to be a debt to be repaid. The CARES Act legislation that created the PPP specified that the forgiven loan amount would not be taxable income, and that has not changed. However, the Internal Revenue Service (IRS) has ruled that the expenses equal to the amount of loan forgiveness will not be deductible for federal tax purposes.
There had been a question of timing and how to handle the loan, income, and expenses until everything is finally settled. The IRS now says that if the practice files its forgiveness application and receives approval in the same tax year (say, the calendar year of 2020) then everything lines up easily – no income from the PPP loan forgiveness, and no deduction for the equivalent expenses.
However, if forgiveness is delayed until calendar year 2021 (or a fiscal tax year beyond 2020) then the expenses will be incurred in one year and the income recorded in the following year. The IRS ruling states that the practice “may not deduct those expenses [in 2020] if, at the end of , the taxpayer reasonably expects to receive forgiveness of the covered loan” and goes on to say, “even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of .” The deductibility hinges on the intent of the practice to seek loan forgiveness.
Practices may deduct the full amount of the expenses under an IRS Safe Harbor provision if they elect not to apply or accept loan forgiveness, or if their application for forgiveness is denied. In other words, they would have to fully repay the amount of the PPP loan in order to deduct the full amount of their 2020 expenses.
Accountants are generally recommending that filing of the fiscal 2020 tax return be extended as long as possible until all the facts are known, but practices should work closely with their own accountants to set up a December 2020 financial plan.
A Quick Review of the Paycheck Protection Program
The purpose of the loan program was to assist practices in maintaining their employees’ compensation and to cover certain necessary, fixed expenses during the economic downturn created by the COVID-19 Public Health Emergency (PHE). Initially the funds were to be expended over an eight-week period for payroll and other defined costs, but the covered period was later extended to 24 weeks for loans that originated on or after June 5, 2020; practices that received an earlier loan have a choice of either an 8- or 24-week covered period. In any case, the covered period is scheduled to end no later than December 31, 2020.
At least 60% of the amount spent must be for payroll and related employee costs such as payroll taxes and benefits. The remaining 40% can be used for rent, utilities, and interest on business loans that were in place prior to February 15, 2020. Payroll costs are capped at $15,385 per person if the 8-week period is used, or $46,154 per person if the 24-week period is used. Practice owners of more than a 5% share are limited to compensation of $20,833 per person. This is a recent clarification, as previously ‘owners’ were defined as those with a share of 20% or more.
Practices must also maintain the wage rates in effect from January 1 to March 31, 2020, and the average employment level (both in hours and the number of employees) that was in existence between either February 15 to June 30, 2019, or January 1 to February 29, 2020. If there was a reduction of wages or employment level then the practice has until December 31, 2020 to restore them without affecting its loan forgiveness.
Recent Clarification of Certain Rules
- The owner-employee compensation cap of $20,833 per person does not apply to corporate shareholders of 5% or less. Their cap will be $46,154 per person, the same as it is for any other employee with annual earnings in excess of $100,000.
- Payments of rent to a related party are eligible expenses provided that the amount of rent is no more than the amount of mortgage interest owed on the property during the covered period, and provided the lease and mortgage were both entered into prior to February 15, 2020. The effect of this rule is to equalize the amount eligible for forgiveness regardless of whether the property is owned by the practice or a separate entity. According to the rule, “Any ownership in common between the business and the property owner is a related party for these purposes.”
- Expenses attributable to the business operation of a tenant or sub-tenant of the practice are not eligible for forgiveness.
Which Form to Use?
There are currently 3 forms that could be used to apply for loan forgiveness, depending on the practice’s circumstances. Of note is the subtle revision of the rules for users of Form 3508S, which was introduced on October 14, 2020.
Form 3508 EZ
Use if any one of these conditions is true:
Where Are We Now?
The covered period will end by December 31, 2020. Repayment of any unforgiven loan balance will not be required for up to 10 months following the end of the covered period, or October 31, 2021 at the latest. The application for loan forgiveness can be filed at any time prior to the expiration of the 10-month period. Some banks are currently processing loan forgiveness, while others are not yet accepting applications. As long as the application is submitted by the 10-month deadline, no payment of principal or interest will be required until the amount of forgiveness has been determined and the funds received by the lending bank.
The lending bank has up to 60 days to respond to the forgiveness application and indicate the amount of the loan that will be forgiven. The Small Business Administration (SBA) then has 90 days to review the application and remit the forgiveness funds to the lender. If the amount of the forgiveness does not come up to the full amount of the original loan, then the practice has 5 years to repay the remaining balance with interest at 1% per annum. There is no penalty for repaying the full unforgiven balance immediately.
If forgiveness of the full loan amount is expected, then there is no benefit to submitting a loan forgiveness application earlier than the end of the covered period. However, interest at 1% per annum accrues on any unforgiven balance beginning with the original date the loan was disbursed. Practices that will not be able to receive full forgiveness should be aware of this when considering the timing of their application.
Some Questions Remain
Some sources indicate that the PPP rules might continue to change, as with the recent introduction of Form 3508S described above, so there is some basis for waiting to file for forgiveness at least until January 2021. There is also reason to expect that the deductibility of expenses giving rise to the PPP loan forgiveness could change in 2021 retroactively to 2020.
While we strive to be as thorough and accurate as possible, nothing in this article should be construed as legal, accounting, or tax advice, and practices should consult with their accountants, attorneys or other advisors as necessary.
We will continue to monitor and report on significant events that will assist your practice to maximize the benefit of this important program. Subscribe to this blog for the latest information.