Congress recently passed legislation materially changing the Paycheck Protection Program (PPP) for both new and existing PPP loan borrowers, which was later signed into law by President Trump. We have outlined below the key PPP changes introduced by this new legislation if it becomes law.
Let us help you make sense of how these new PPP provisions affect you.
PPP Expenditures Deduction
We have discussed in prior insights how the government previously decided that eligible expenditures giving rise to PPP loan forgiveness are not deductible for tax purposes. Many commentators and politicians were critical of this government holding. The new legislation settles the dispute by providing that forgiven PPP loans do not produce taxable income and eligible expenditures giving rise to forgiveness are tax deductible.
The new legislation also provides a tax basis increase for partners and S corporation shareholders when a partnership or S corporation’s PPP loan is forgiven, by treating the forgiven loan as a form of “tax exempt income.” For partnerships, this allows partners to match their tax basis to their allocable share of PPP expenditures, resulting in no suspended deductions (the PPP provides debt basis to the partner, and when the loan is forgiven the tax-exempt income raises basis).
S corporations and S corporation shareholders generally can achieve a similar result, except there is an open question concerning whether a S corporation shareholder can increase their tax basis in a current year (2020) if the underlying S corporation’s PPP loan is forgiven in subsequent year (2021) (because unlike a partnership, S corporation debt does not generally increase a S corporation shareholder’s basis). In such circumstances, the “tax exempt” income and related basis increase would appear to arise in the 2021 tax year, yet the eligible expenditures are allocated to the S corporation shareholder for the 2020 tax year. This could result in temporarily suspended tax losses (or cash distributions to S corporation shareholders triggering gain recognition), although further governmental guidance could change this result.
PPP Second Draw Loans
A second round of PPP loans (called “second draw loans”) is authorized by this new legislation. Eligible entities with not more than 300 employees that can demonstrate at least a 25% reduction in gross receipts in the first, second, or third quarter of 2020 as compared to the same quarter in 2019 can apply for a second draw loan. Eligible entities applying after January 1, 2021, can use their 2020 and 2019 fourth quarter gross receipts. Entities not in business as of February 15, 2020, are not eligible for second draw loans. There is no further guidance on how to measure gross receipts (for example, is it a cash or accrual concept) so borrowers will need further governmental guidance before applying.
For purposes of measuring the number of employees, rules of affiliation can cause multiple businesses to be grouped together as a single business. However, similar to the first round of PPP loans, businesses with the NAICS code 72 (generally restaurants and the hospitality industry) are not required to apply the rules of affiliation and can test each stand-alone business location on its own. Similar rules apply for dealerships listed in the SBA’s dealership directory.
Second draw laws are generally capped at the lesser of 2.5 months of a borrower’s average payroll (for either the 2019 tax year or the trailing 12 months before application date) or $2 million. Eligible businesses with the NAICS code 72 can use the lesser of 3.5 months of payroll or $2 million. There are special rules for measuring the payroll of seasonal borrowers.
Like the first round of PPP loans, PPP second draw borrowers generally must use 60% of the loan proceeds on payroll, and borrowers can be subject to forgiveness reductions if they reduce their full time equivalency (FTE) counts or certain employee salaries by more than 25%. The remaining 40% can be used on qualified overhead like rent, mortgage, and utilities. The new legislation also created new categories of eligible non-payroll expenses for both existing and new borrowers, including:
With this new legislation, Congress has also expanded the list of potential borrowers to include certain news organizations and certain section 501(c)(6) organizations. “Shuttered venue operators” are eligible for special grant programs as well.
Finally, Congress makes it clear that PPP first round borrowers can also make use of the PPP second draw program if they meet all other eligibility criteria and if the borrower on or before the PPP second draw disbursement date “has used, or will use, the full amount of the loan received. …”
New PPP Loan Forgiveness Parameters
There are new forgiveness rules for both existing and new PPP loans not exceeding $150,000. Essentially, borrowers will only need to complete a one-page forgiveness application with associated certifications and attestations about the loan and uses of the proceeds. No supporting documentation is required; however, borrowers are required to retain documentation related to employment for four years and other records for three years. We expect the government to issue a new forgiveness form reflecting these changes.
Both existing and new borrowers with PPP loans in excess of $150,000 are still subject to the existing forgiveness rules and forms.
Covered Period for PPP Loans
The government previously stated that existing PPP borrowers must choose (if eligible) either an eight week or 24 week covered period (generally the time period during which a borrower can pay and/or incur eligible expenditures giving rise to forgiveness), although the government also stated borrowers can apply for forgiveness before the end of their covered period.
Unstated is whether a borrower applying early must maintain FTE counts until the end of the covered period. The new legislation lets a borrower choose a covered period between the eight weeks and 24 weeks, apparently resulting in the borrower testing FTE counts (and any applicable employee salary reductions) as of the date of application, because the chosen date of the application is the end of the borrower’s covered period.
The PPP and Other Programs, Including ERC and EIDL
Congress previously created the Employee Retention Credit (ERC), alongside the PPP, to encourage borrowers to retain their workforce during the COVID-19 pandemic. As originally enacted, a taxpayer could not make use of both the PPP and the ERC.
The new legislation now allows a PPP borrower to also make use of the ERC, although the borrower cannot use wages that give rise to PPP forgiveness for ERC purposes. This results in existing PPP borrowers potentially being eligible for the ERC for past quarters, and going forward eligible borrowers may be able to claim both the PPP and ERC (the new legislation also increases the ERC benefit for the first two quarters of 2021).
Congress also previously stated that a recipient of an Economic Injury Disaster Loan (EIDL) grant must reduce any PPP forgiveness by the amount of the grant. The new legislation eliminates this requirement, meaning a PPP borrower who also receives an EIDL grant does not need to reduce their potential PPP loan forgiveness amount. In addition, the legislation would treat EIDL advances, as well as SBA 7(a) loan subsidies, similar to PPP forgiveness—i.e., the advances and subsidies would not produce taxable income and related expenditures would remain tax deductible.
Finally, the new legislation extends the Families First Act’s credit (but not the obligation to provide) sick and family leave through March 31, 2021. Claiming this credit does not prohibit the receipt of a PPP loan, but individual payroll costs can only be considered for either a PPP loan or the Families First credit, not both.
What You Need to Know About New PPP Legislation
The PPP second draw loans provide welcome relief for eligible entities effected by the pandemic. The ability to choose which 2020 quarter a borrower uses to calculate a reduction in gross receipts may provide planning opportunities. Congress instructed the government to “issue regulations to carry out” the new legislation within 10 days of enactment.
We expect new guidance from the government in the next few weeks, including new PPP second draw application forms, as well as new forgiveness forms, so potential borrowers should continue to monitor the PPP for further updates.
There is much to consider when it comes to PPP loans and the new legislation. We can help you walk through compliance and forgiveness to maximize the loan’s benefit.
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