For many CPAs, the Paycheck Protection Program (PPP) program has perhaps been the biggest challenge of the year. With $552 billion going to 5.2 million borrowers, the program has affected businesses across the country. Accountants have largely been tasked with guiding businesses through the process.
Despite the constant stream of rules and regulations coming out of the Small Business Administration (SBA) and the Treasury Department, important questions remain, especially with regard to timetables, loan forgiveness and tax deductions related to forgiven amounts. Below we discuss the most recent guidance and the key issues businesses face right now in managing their loan forgiveness requests.
There have been several updates on PPP loans over the last month relating to:
- clarification of the loan deferral period
- simplified application procedure for forgiveness of loans of $50,000 or less
- how EIDL grants offset PPP loan forgiveness
- change of ownership guidance
- Form 1099-C relevancy
Below is an explanation of recent changes, along with an analysis of continuing uncertainties and considerations businesses need to address now when preparing for loan payback or forgiveness.
The SBA has clarified in FAQs that the deferral period for PPP loans is the longer period allowed under the Payroll Protection Program Flexibility Act of 2020, which is: 1) the date that SBA remits the borrower’s loan forgiveness amount to the lender; or 2) if the borrower does not apply for loan forgiveness, 10 months after the end of the borrower’s loan forgiveness covered period. For example, a borrower whose covered period ends on October 30, 2020 has until August 30, 2021 to apply for forgiveness before loan repayment begins.
Previously, the deferral period could end after 6 months. Also, borrowers have been confused because the forgiveness forms had a 10/31/2020 expiration date at the top. That date should be disregarded. Lenders and borrowers are not required to modify promissory notes used for PPP loans to reflect the extended deferral period, but lenders are supposed to notify borrowers of the change to the deferral period.
The SBA began approving PPP forgiveness applications and remitting forgiveness payments to PPP lenders on October 2, 2020. The SBA says it will continue to process all PPP forgiveness applications in an “expeditious manner.” With the above clarification, here is the current timeline for forgiveness applications.
Forgiveness Process Timeline
Simplified Procedure for $50,000 loans
The SBA has released a simpler loan forgiveness application for PPP loans of $50,000 or less. (Please note this form still has the 10/31/2020 deadline, which no longer applies.) An interim final rule issued with the new form exempts borrowers with these smaller loans from a reduction of loan forgiveness based on:
1) reductions in full-time equivalent (FTE) employees, or
2) reductions in employee salary or wages.
The SBA notes that there are approximately 3.57 million outstanding PPP loans of $50,000 or less, totaling approximately $62 billion of the $525 billion in PPP loans.
The SBA also clarified in the interim rule that the amount of loan forgiveness that a borrower may receive cannot exceed the principal amount of the PPP loan. If documentation is submitted for higher amounts, the lender is to confirm the borrower’s calculations on the borrower’s loan forgiveness application, up to the amount required to reach the requested forgiveness amount.
EIDL Reduces Forgiveness
Borrowers cannot double dip with Economic Injury Disaster Loan (EIDL) advances and PPP loan forgiveness. SBA said in FAQs that it will deduct the amount of any EIDL advance received by a PPP borrower from the forgiveness amount remitted to the lender. A borrower that received an EIDL advance in excess of the amount of its PPP loan will not receive any forgiveness, because the amount of an EIDL advance is deducted from the PPP loan forgiveness amount.
The lender will be able to confirm the amount of the EIDL advance that will be automatically deducted by SBA from the forgiveness payment by reviewing the borrower’s EIDL advance information in the PPP Forgiveness Platform, the website where lenders submit their forgiveness decisions to the SBA.
Change of Ownership
Borrowers that want to sell their businesses have been concerned with the PPP rules that apply when there is a change of ownership between the time the business gets a loan and before the loan is paid back. The SBA issued a procedural notice to SBA employees and PPP lenders defining ”change of ownership” and explaining the responsibilities of the parties going forward.
A “change of ownership” will be considered to have occurred in any one of three circumstances:
(1) at least 20% of the common stock or other ownership interest of a PPP borrower (including a publicly traded entity) is sold or transferred, whether in one or more transactions, including to an affiliate or an existing owner of the entity.
(2) the PPP borrower sells or transfers at least 50% of its assets (measured by fair market value), whether in one or more transactions.
(3) a PPP borrower is merged with or into another entity.
Regardless of any change of ownership, the PPP borrower remains responsible for:
- performance of all obligations under the PPP loan.
- certifications made in connection with the PPP loan application, including the certification of economic necessity.
- compliance with all other applicable PPP requirements.
The PPP borrower also remains responsible for obtaining, preparing, and retaining all required PPP forms and supporting documentation and providing those forms and supporting documentation to the PPP lender or lender servicing the PPP loan or to SBA upon request.
The PPP borrower must notify the PPP lender in writing of the proposed transaction before closing and provide the PPP lender with a copy of the agreements or other documents relating to the proposed transaction.
There are no restrictions on changes in ownership if the borrower has paid back the loan or the SBA has remitted the forgiven amounts to the lender.
If the note is not fully satisfied before the sale, different procedures apply, depending on whether the ownership change is a stock sale, merger, or asset sale. In some circumstances, the PPP borrower must get SBA approval and must complete and submit a forgiveness application and establish an interest-bearing escrow account controlled by the PPP lender equal to the outstanding balance of the PPP loan. After the forgiveness process is complete, the escrow funds must be disbursed first to repay any remaining PPP loan balance plus interest.
No 1099-Cs Required for Forgiveness
The IRS has notified lenders in Announcement 2020-12 that they do not need to file a Form 1099-C, Cancellation of Debt, with the IRS or the borrower to report the forgiveness amount. Form 1099-C is usually filed by an entity to report any discharge of debt of at least $600, which is potentially taxable. PPP loan forgiveness amounts are not taxable.
Planning Ahead for Forgiveness, Tax and Financial Effects
The PPP loan forgiveness process can have far-reaching effects on a business’s tax liability, yearly planning, and financial reporting. Because the forgiveness process can straddle two years and the repayment process can extend up to five years, businesses need to consider the effects of PPP loans over the long term.
Two outstanding issues make planning and projections difficult. First, Congress may give blanket forgiveness to loans up to a specific dollar limit. Next, Congress may act to allow the deduction of expenses related to PPP loans which, currently, are not deductible. Let’s consider these two possibilities.
While the SBA has acted to make forgiveness easier for borrowers with loans of $50,000 and under, some in Congress are pushing blanket forgiveness for small loans. Sen. Kevin Cramer (R-N.D.) introduced S. 4117, Paycheck Protection Small Business Forgiveness Act, (with H.R. 7777 as the House companion bill) which has the bipartisan support of 31 other senators and would forgive PPP loans up to $150,000 if the borrower submits to the lender a one-page document that attests the borrower complied with the PPP loan requirements. This provision also has made it into the main House and Senate (H.R. 925 and S. 4775) stimulus bills pending before Congress.
Such blanket forgiveness would greatly simplify and speed up the process for small loans, possibly keeping PPP issues within the 2020 tax and financial reporting period. On the other hand, if these smaller loans are completely forgiven, borrowers face losing their tax deductions for expenses covered by PPP forgiveness amounts, unless Congress changes that, too.
The other major area of uncertainty relates to a notice the IRS put out in April 2020 which states that no deduction will be allowed for expenses paid using PPP funds to the extent loan amounts are forgiven. Normally, the covered expenses, such as payroll, mortgage interest, rent, and utilities, are deductible business expenses. The IRS’s position is that, because loan forgiveness amounts are not included in income under the CARES Act, allowing related deductions would result in a “double tax benefit.” Despite criticism from members of Congress and accounting organizations, the IRS stood behind this stance in revenue ruling (Rev. Rul. 2020-27) in mid-November.
This position, which has been criticized by some members of Congress and accounting organizations, would be reversed by legislation pending in Congress though its prospects are unclear. S. 3612, the Small Business Expense Protection Act, has been introduced by Senate Finance Committee Chairman John Cornyn (R-Tx) and a companion bill, H.R. 6821, has been introduced in the House. These bills provide that no deduction will be denied or reduced, no tax attribute will be reduced, and no basis increase will be denied, because of the exclusion from gross income of forgiven PPP loan amounts.
Despite wide bipartisan support, there is no guarantee this provision will make it into any new stimulus bill. Even if it does, no one knows when or if Congress and the Administration will reach an agreement and enact new stimulus legislation, either before the election or, even less likely, in the lame-duck session after the election.
At this point, we have to assume that current law will remain in effect through 2020. That means borrowers should not count on the fact that their loans under $150,000 may be completely forgiven. For now, it is still important for borrowers to maintain their payrolls and carefully document their forgivable expenses so they can get the maximum amount forgiven.
Borrowers with an 8-week covered period may have a forgiveness decision made before the end of the year, but those with a 24-week covered period likely will not know until 2021 whether some or all of their loan is forgiven. Borrowers can go ahead and apply for forgiveness before the end of their covered period, but this move may not be advantageous. Taking the full 24 weeks gives borrowers more time to expend funds to get higher forgiveness amounts. Waiting also gives more time for Congress to take action and provide more guidance.
Borrowers also may not know if expenses related to forgiveness amounts will be deductible. Again, borrowers have to assume they are not until there is formal action by Congress and the President. In this case, delaying 2020 tax filings as long as possible may be the best approach to get a clear picture of the rules that will apply. Realize that amended returns may be necessary.
Loan forgiveness also can impact your financial reporting both in 2020 and in 2021. The AICPA has issued guidance on how to account for loan forgiveness. Forgiven loans can be treated either as debt or as a government grant. For debt treatment, an entity may account for the loan as a financial liability and accrue interest. An entity would not impute additional interest at a market rate. The entity would record proceeds from the loan as a liability until either:
(1) the loan is, in part or wholly, forgiven and the debtor has been “legally released” or
(2) the debtor pays off the loan to the creditor.
Once the loan is forgiven and a legal release is received, a nongovernmental entity would reduce the liability by the amount forgiven and record a gain on extinguishment.
If an entity treats the loan as a grant, it would not be recognized as government assistance until there is reasonable assurance that any conditions attached to the assistance will be met and the assistance will be received.
PPP loan forgiveness and payback can have tax, financial reporting, and cash flow impacts and borrowers have to carefully consider how both existing law and proposed changes may affect them. Consult your Frazier & Deeter PPP specialist to formulate a comprehensive PPP strategy now.