July 31, 2020
The Paycheck Protection Program Flexibility Act of 2020 (H.R. 7010, P.L. 116-142) was signed by the President on June 5, 2020, and it makes significant changes to the original PPP loan program. These changes are important for clients who have already borrowed funds and for those who might still apply. The PPP program was put together quickly, and since the original enactment, there have been numerous interim final rules and FAQs issued by the Treasury and the SBA. This has left borrowers and their advisors in a difficult position when deciding how the loan funds could be spent and what specific requirements must be met for forgiveness to apply.
While this new Bill offers a longer period to use loan proceeds and qualify for forgiveness, borrowers should be aware of new rules regarding full-time equivalent employees (FTEEs) and changes to the threshold for forgiveness of nonpayroll costs.
PPP Loan Background (CARES Act March 27, 2020)
As the CARES Act was originally passed, businesses with 500 or fewer employees, in operation on February 15, 2020, were generally eligible for 2½ times the business’s average monthly payroll over either the prior 12 months or for 2019 (up to a maximum loan of $10 million). The per-employee payroll to be used in the calculation was limited to a $100,000 annual maximum payroll amount. Some of the loan may be forgiven and, for the remaining debt, the interest rate would have only been 1%.
The Paycheck Protection Program loans can be used for the following expenses:
The loans may be forgiven for amounts used for these expenses for up to eight weeks from the loan origination date. The Act stated that borrowers are only allowed 100% loan forgiveness if at least 75% of the total loan proceeds are used for payroll costs. However, loan forgiveness would also have been reduced by reductions in employee compensation or layoffs of employees during the period of February 15, 2020, through June 30, 2020.
Any loan amount that was not forgiven had a term of two years and an interest rate of 1%. No payments would be required for the first six months, though interest would continue to accrue during that time.
New PPP Bill – Paycheck Protection Program Flexibility Act of 2020 June 5, 2020
This Act enhanced many of the CARES Act requirements to allow borrowers to achieve maximum forgiveness of their PPP loans.
Extended Forgiveness Period
The loan forgiveness covered period was extended from eight weeks (beginning on the date the loan was received) to a period ending the earlier of:
This new 24-week forgiveness period will apply to all borrowers who receive the loan after June 5, 2020. However, borrowers that received their loan prior to June 5, 2020, may elect to use either the original eight-week loan forgiveness period or the new 24-week period.
This extended period means that borrowers are more likely to have all PPP loan amounts received during this extended covered period forgiven, assuming the amounts were expended for qualified purposes (payroll, rent/mortgage interest, and utilities). Additionally, the extended period also allows the SBA to continue clarifying questions that have arisen over what constitutes a qualified expense under the Act.
Loans are based on 2 ½ months of payroll costs, so spending that amount in 24 weeks should be no problem for many borrowers.
The one consideration that borrowers must keep in mind with this longer forgiveness period is that their average FTEEs are also measured over a longer period.
New Threshold for Payroll Costs
The Act states that borrowers are only allowed loan forgiveness if at least 60% of the total loan proceeds are used for payroll costs. As a reminder, Congress created the PPP to put and keep people on the payroll, even if there was no work for those employees, effectively using the private sector payroll departments to deliver government benefits to employees. As a result, the level of loan forgiveness is directly tied to payroll costs over a 24-week period and may be reduced based on certain payroll-related calculations. Three types of events can trigger a reduction in the amount of loan forgiveness:
Full-Time Equivalent Employees (FTEE)
If the average number of FTEEs during the covered period for loan forgiveness is less than the comparable FTEE period, the loan forgiveness is reduced. Borrowers who maintain their number of FTEEs will benefit from the 24-week period because they should easily use their full loan on payroll costs. For borrowers who are struggling and may have to lay off employees, they should consider the forgiveness difference between the 8-week and 24-week periods.
Rehire FTEE Reduction Exception
The new Act gives employers until December 31, 2020, to replace their FTEEs without having to reduce their loan forgiveness amounts. The Act also contains a provision eliminating the FTEE reduction if the business can document that the reduction was due to the business’s inability to:
So, businesses that will be able to replace their FTEEs by the end of 2020, or that are unable to rehire employees for one of the above reasons, would benefit from the 24-week period.
New Loan Terms
In addition to the new forgiveness provisions, the Act allows for a five-year rather than a two-year maturity date for:
The Act also defers payments of principal, interest, and fees on any PPP loan until the SBA approves the borrower’s loan forgiveness amount to the bank (previously, this period was six months to one year from the loan origination date).
Payroll Tax Deferrals
The Act allows taxpayers to qualify for payroll tax deferral provided under the CARES Act, even if they have received PPP loan forgiveness.
Tax Consequences of PPP Loans
The PPP program that has provided so much help for small businesses has also created a potentially significant tax problem for those very same beneficiaries.
Expenses paid with PPP loan proceeds – The IRS has said the expenses used in the forgiveness calculation, which include payroll, health insurance, retirement contributions, rent, utilities and mortgage interest, are also not deductible, to extent of any PPP loan forgiveness (see cancellation of indebtedness income).
However, the IRS’s position on this issue has been heavily criticized, and key members of Congress have said that the denial of the deduction for these expenses is inconsistent with legislative intent that forgiveness of PPP loans be a nontaxable event. Congress may pass new legislation directing the IRS to allow deductions for expenses paid with the proceeds of PPP loans. At this time, nothing has been proposed.
Cancellation of indebtedness income – The reduction or cancellation of indebtedness generally results in cancellation of debt (COD) income to the debtor. However, the forgiveness of PPP debt is excluded from gross income. Your tax attributes (net operating losses, credits, capital and passive activity loss carryovers, and basis) would not generally be reduced on account of this exclusion.
We strongly urge you to review your 2020 tax planning, taking into account the non-deductibility of any of the expenses used in the PPP loan forgiveness calculation. If you do not take action now, you could be in a cash crunch when your tax bill comes due. Note that for California tax purposes, the loan forgiveness is taxable and the costs are deductible.
Other COVID-19 Business Relief Options
The following are some of the COVID-19 business relief options defined in the Families First Coronavirus Response Act (FFCRA) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act:
The above tax credits interact with other relief provisions. For example, businesses receiving Paycheck Protection Program loans are ineligible for the employee retention credit.
We anticipate updates and further qualifications to the above COVID -19 legislation; therefore, please contact our office with any questions and the latest information. We wish all of you the very best in a difficult time.