The Paycheck Protection Program (PPP) is a small business loan program backed by the Small Business Association that was born out of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The first iteration of the program allocated $350 billion towards American small businesses and was subsequently expanded to provide an additional $310 billion. Each business was eligible for up to $10 million.
The money was to be utilized by businesses over eight-week periods to assist with cash-flow. PPP loans were 100 percent federally guaranteed loans. Following the initial rollout, additional provisions for the funding have been added. For example, the Paycheck Protection Program Flexibility Act allows for added weeks to spend the funds and creates a path for loan forgiveness.
The PPP was a lifesaver for many large and small businesses. However, as year-end approaches, there are many questions related to forgiveness requirements, appropriate tax filings, and more.
Qualifying for Loan Forgiveness
The Paycheck Protection Program Flexibility Act dictated that funds received under the PPP program are eligible for forgiveness if certain criteria are met. For many businesses, this will have the effect of essentially converting loans into federal grants. Generally, in order for businesses to receive forgiveness, they must have been used for the following purposes:
– Payroll: At least 60 percent of the total money received must be spent on payroll expenses. This can include salary, sick/vacation time, family leave or health benefits. However, note that you must retain the same number of employees that were present on your payroll at the time you were granted the loan.
There is an exemption to this requirement for employees who were employed as of February 15, 2020, but were laid off or furloughed and later offered rehire and declined.
– Mortgage Interest or Rent Payments: Whether your business owns or rents, you can use the funds for the cost of maintaining your shop as long as the mortgage or lease agreement was entered into before February 15, 2020
– Utilities: Similarly, as long as service began before February 15, 2020, funds spent on utilities such as water, power, internet, etc. have the potential to be forgiven.
Furthermore, only expenses incurred over the 24 weeks period following the day the first payment was made to you by your lender (this may not be the same date that your loan agreement was signed) are eligible.
There are also special carve outs depending on the structure of your business.
Self-employed individuals or sole proprietors are eligible to claim up to 2.5 months of their 2019 net profit to replace 2020 lost compensation, whereas general partners in a partnership can calculate compensation based on the partnership’s 2019 net earnings.
Good recordkeeping and accounting are of the utmost importance when applying for loan forgiveness. You will need to track and provide documentation of eligible expenses and how the loan funds were applied for the entire 24-week period.
Navigating the New Tax Code
The expenses covered by PPP loans (and reasonably eligible for forgiveness) can’t be deducted on 2020 tax returns. The IRS asserts that it would lead to “double benefit” since those expenses were already paid for by the federal loans.
The CARES Act does specify, however, that the forgiven loan amount won’t be included in taxable income. Meaning small businesses will not pay taxes on PPP loan money received. This makes the most sense, since the goal of PPP loans was to provide relief for businesses facing dramatic losses and even closure, not to create a tax burden for businesses receiving the funds.
Despite this provision, taxes for the year 2020 are sure to be challenging all around. The IRS has issued numerous pieces of guidance and regulation this year and individuals, small businesses, and tax professionals will have a hard time navigating through the intricacies.
One such thing to consider, depending on the specifics of your business’ finances, is that since you lose out on some tax deductions you may find yourself paying more when all is said and done even with the exclusion of the loan funds.
For example, businesses structured as corporations who received $50,000 through a PPP loan and used it entirely on qualified expenses won’t have that money included as taxable income at the end of the year.
However, they also will not be able to claim a $50,000 tax deduction that they would apply in a normal year for those same expenses. As such, your business could end up with an extra $10,500 tax liability at the end of the year ($50K x 21% corporate tax rate) that you likely would not have had if you had taken the deductions as you normally would.
In this sample scenario, your business would still be ahead overall, with a net benefit of $39,500 thanks to the loan money, and it would have served its purpose by keeping you afloat for several months. But for some business owners, this may be a big end-of-year tax surprise
As a result of this mostly unforeseen and potentially expensive effect on already struggling businesses, many argue that given the hardship felt in 2020, Congress intended the loans to serve a double benefit. There is currently lobbying and petitioning underway to reverse the IRS’ decision.
Additionally, the recent stimulus proposal, the HEROES Act, would reverse the decision that these expenses can’t be deductible if passed.
Even if this issue is resolved in favor of small businesses, adhere to the new guidelines and tax code while maximizing your benefit will be tricky. It’s important that you begin consultation with your tax professional early to avoid being alarmed and unprepared come tax time.
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This article is intended for informational purposes only and does not constitute legal advice for your specific situation. Use of and access to this article does not create an attorney-client relationship between you and Counxel Legal Firm. Please contact request@counxel.com or (480) 744-6621 to request specific information for your situation.
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