Below is some recent guidance on the PPP. This email is slightly longer than my usual PPP email, as these recent developments are very important and these topics require everyone’s attention who are expecting 100% or partial forgiveness.
1-Non-deductibility of 2020 expenses funded by PPP funds that are forgiven.
This is extremely important for businesses to review and consider how it affects their 2020 year-end tax planning. Secretary Munchkin stated that if the government paid your expenses, then you shouldn’t be entitled to deduct those expenses. Accordingly, the IRS confirmed its position that business expenses paid with the Payroll Protection Program funds that are forgiven CAN NOT BE DEDUCTED for federal income tax purposes.
The purpose of the PPP was to give small businesses low-interest loans to assist them to fund payroll costs and certain benefit costs, rent, utility, and certain interest costs during these trying times. If a business met certain criteria and fully utilized the PPP funds for qualified expenses, then that business can apply for complete forgiveness of the PPP loan. The forgiven amount would be reduced if your business didn’t adhere to the PPP rules. The CARES Act provided for any PPP loan that is forgiven will not be taxable income. Without such provision, any forgiven loan generates taxable income – so this tax exemption was viewed as a huge benefit to those businesses that obtained forgiveness. While the CARES Act specifically addressed the forgiveness part of the PPP loan, it didn’t address the deductibility of the expenses that the PPP loan funded. Many business and tax folks wondered whether the expenses are deductible.
The IRS recently issued IRS Revenue Ruling 2020-27 and it concluded that the tax laws did not intend to offer businesses a double benefit – tax-exempt income for the forgiveness and tax-deductible expenses. Accordingly, the IRS and Treasury Department has ruled that if a business can reasonably expect to have any PPP loan forgiven, then those expenses that are paid with those forgiven amounts will not be deductible. A quick summary is as follows:
Business with partial loan forgiveness- if a business only has partial forgiveness of its loan, it may still have deductible expenditures attributable to the non-forgiven portion.
Business with entire loan forgiveness- If a business receives full forgiveness, then a business should be tax neutral for federal income tax purposes.
The Treasury Department is encouraging businesses that reasonably expect to have some or all of the PPP loan forgiven to file for forgiveness as soon as possible. Many businesses are doing their year-end tax planning without knowing whether some or all of the PPP expenses are deductible or not.
Conclusion – Businesses owners that are expecting to have PPP forgiveness will see much higher tax liabilities in April so they need to incorporate into their cash flow these additional tax payments. I know many businesses didn’t see this coming so many trade organizations and business owners are reaching out to their Congress members trying to pass CARES Act 2 that allows these expenses to be deductible.
2- PPP loans in excess of $2 million.
Those that borrowed in excess of $2 million in PPP money, will have to complete a loan necessity questionnaire with its forgiveness application. The SBA will be reviewing all PPP loan forgiveness applications in excess of $2 million along with the loan necessity questionnaire. This covers questions dealing with your business activity and liquidity assessments. First observation, it will take a significant amount of time to properly answer these questions. Secondly, these questions are asking about how your business performed during the “Covered Period”. Lastly, the application requires a business to support the answers by providing supporting documentation. Businesses required to complete this questionnaire will only have 10 business days turnaround to respond. While this questionnaire is required for loans in excess of $2 million requesting forgiveness, I can see the SBA or the bank asking to complete this questionnaire for loans under $2 million on a random basis. The $2 million thresholds are determined by including all affiliated entities.
Some selected questions from the questionnaire that have to be answered are as follows:
What was the borrower’s gross revenue in the second calendar quarter (Q2) of 2020? If the borrower existed in Q2 2019, what was the borrower’s gross revenue in Q2 2019? If the borrower did not exist in Q2 2019, what was the borrower’s gross revenue in the first calendar quarter (Q1) of 2020? (Seasonal borrowers may provide gross revenue information for the third calendar quarter (Q3) of 2020 and 2019.)
Since March 13, 2020 (date of National Emergency Declaration by President Trump), has borrowers been ordered to shut down by a state or local authority due to COVID-19? Which state or local authority? Provide the start and end dates (or ongoing).
At any time since March 13, 2020, has the borrower been ordered to significantly alter its operations by a state or local authority due to COVID-19? Provide the start and end dates (or ongoing). What were the borrower’s approximate additional Does cash outlay for these mandatory alterations? How were borrower’s operations altered due to the order –
o the number of people permitted in a location at one time was reduced or capped
o Service was restricted to outdoors
o Employee work-spaces were reconfigured
o Other (describe)?
At any time since March 13, 2020, has borrower voluntarily ceased or reduced its operations due to COVID-19? Provide the start and end dates (or ongoing). Why did borrower voluntarily cease or reduce operations –
o Employee(s) contracted COVID-19
o Borrower’s supply chain (e.g., a supplier of goods or services that are essential to borrower’s operations was unable to deliver due to COVID-19)
o Other (describe)?
At any time since March 13, 2020, has the borrower voluntarily altered its operations due to COVID-19 (other than ceasing or reducing operations)? Provide start and end dates (or multiple start/end dates if staggered). What were borrower’s approximate additional cash outlay for these voluntary alterations? How were borrower’s operations voluntarily altered –
o the number of people permitted in a location at one time was reduced or capped
o Service was restricted to outdoors
o Employee work-spaces were reconfigured
o Other (describe)?
Between March 13, 2020, and the end of the loan forgiveness covered the period of the PPP loan, did the borrower begin any new capital improvement projects not due to COVID-19? If yes, what were the borrower’s approximate cash outlays for those projects?
What is the borrower’s primary six-digit NAICS code?
As of the last day of the calendar year immediately before the date of the borrower’s PPP loan application, how much did the borrower own in cash and cash equivalents?
Between March 13, 2020, and the end of the loan forgiveness covered the period of the PPP loan, has the borrower-paid any dividends or other capital distributions (other than for pass-through estimated tax payments) to its owners? If yes, what was the total amount of all dividends or other capital distributions between March 13, 2020, and the end of the loan forgiveness covered the period of the loan?
Between March 13, 2020, and the end of the loan forgiveness covered a period of the PPP loan, has the borrower prepaid any outstanding debt (i.e., paid before contractually due)? If yes, how much?
During the loan forgiveness covered the period of the PPP loan, where any of the borrower’s employees compensated in an amount that exceeds $250,000 on an annualized basis? (Compensation covers gross salary, gross wages, gross tips, gross commissions, and allowances for dismissal or separation.) If yes, how many of such employees were there, and what was the total amount of compensation during the loan forgiveness covered period for all such highly compensated employees?
During the loan forgiveness covered a period of the PPP loan, were any of the borrower’s owners who work at borrower compensated by the borrower in an amount that exceeds $250,000 on an annualized basis? If yes, how many of such owners were there and what was the total amount of compensation during the loan forgiveness period of all such owners?
On the date of the borrower’s PPP loan application, where any of the borrower’s equity securities listed on a national securities exchange? If yes, what was the borrower’s market capitalization on the date of the borrower’s loan application?
On the date of the borrower’s PPP loan application, did any publicly-traded company own 20% or more of any class of borrower’s outstanding equity securities? If yes, provide the name and market capitalization of all such publicly traded companies.
If the answer to the last question is “NO,” what was the book value (shareholder’s equity value) of the borrower as of the last day of the calendar quarter immediately before the date of the borrower’s PPP loan application?
On the date of borrower’s PPP loan application, was the borrower a subsidiary of (i.e., was at least 50% of borrower’s common equity, or equivalent equity interest, owned by) another company (“parent company”)? Was the parent company organized or incorporated outside the U.S.? If any of the equity securities of the borrower’s parent company are listed on a national securities exchange or on a securities exchange in a non-U.S. jurisdiction, what was the market capitalization of the parent company on the date of the borrower’s PPP loan application?
On the date of borrower’s loan application, was 20% or more of any class of borrower’s outstanding equity securities owned by a private equity firm, venture capital firm, or hedge fund (including a fund managed by any such firm)?
On the date of the borrower’s PPP loan application, was the borrower an affiliate or a subsidiary of a foreign, state-owned enterprise (i.e., a company at least 50% owned by a foreign state) or of a department, agency, or instrumentality of a foreign state? Provide a name.
Did the borrower directly receive any funds from any CARES Act program other than PPP, excluding tax benefits? If yes, provide the amount and the program name or describe the funding source.
We are here to help you complete your PPP forgiveness application and I highly recommend seeking proper advice before submitting your forgiveness applications.
If you have any questions then please let me know.
Barry Sunshine
