We live in very uncertain and ever-changing times. With the novel coronavirus pandemic and the federal, state, and local relief efforts, there are so many questions we all have. We want to answer and address some of the questions you might have about your business, and for us as accountants.
The federal response to the economic effects of the pandemic was the CARES Act, which provided 367 billion dollars to American businesses. There are a number of facets of the stimulus package that directly apply to small and medium businesses, including:
- Paycheck Protection Program Loans
- SBA Economic Injury Disaster Loans (EIDL)
- Emergency grants: grants up to $10,000 to provide emergency relief for small businesses
- Existing loan relief: funds to the SBA to cover six months of payments for businesses that have existing SBA loans prior to COVID-19
We are going to speak directly about the questions and taxability of the PPP loans. At the time of publishing this, these are the most up-to-date answers we have, but as we all know, the nature of things are changing every day so we will continue to update this with the newest information.
Paycheck Protection Program Loans
What are the PPP loans?
PPP stands for Payment Protection Program. This loan is intended to cover the payroll costs of businesses affected by COVID-19, although it can also be used for other business expenses, discussed below. Included in the PPP loan calculation are payroll costs, including W-2 wages for employees and benefits such as paid sick leave, health insurance, and retirement plans. The wages considered for the PPP loan are capped at $100,000 on an annualized basis for each employee, otherwise the loan is calculated as 2.5 times the average monthly payroll costs paid in 2019.
Who is eligible?
All businesses, including nonprofits, veterans organizations, Tribal business concerns and sole proprietorships, with 500 or fewer employees can apply for the PPP loan.
What do I use this loan for?
- Payroll costs, including benefits;
- Interest on mortgage obligations, incurred before February 15, 2020;
- Rent, under lease agreements in force before February 15, 2020; and
- Utilities, for which service began before February 15, 2020.
What counts as payroll costs?
- Salary, wages, commissions, or tips (capped at $100,000 on an annualized basis for each employee);
- Employee benefits, including costs for vacation, parental, family, medical, or sick leave; allowance for separation or dismissal; payments required for the provisions of group health care benefits including insurance premiums; and payment of any retirement benefit;
- State and local taxes assessed on compensation; and
- For a sole proprietor or independent contractor: wages, commissions, income, or net earnings from self-employment, capped at $100,000 on an annualized basis for each employee.
How much of the loan needs to be allocated to covering wages?
In June, new legislation was passed and signed, lowering the minimum loan amount required to be spent on payroll from 75 percent to 60 percent.
What time period should borrowers use to determine their payroll costs to calculate their maximum loan amounts?
Payroll costs are based on the average monthly payroll costs incurred in 2019. For seasonal employees, it is the average monthly payroll costs for the 12-week period beginning February 15, 2019, or March 1, 2019, and ending June 30, 2019.
How long do I have to use the PPP Funds in order to apply for forgiveness?
You have an option of 8 weeks or 24 weeks if you received your loan before June 5, 2020. For loans received after June 5, 2020, you must use the 24 weeks for calculating loan forgiveness. The period begins on the date of the first distribution of funds, or the first day of the first pay period following distribution.
When do I have to pay back the loan?
The PPP loan payment will be deferred for ten months after the end of the 8 or 24 week period. Interest on the loan is 1 percent. The repayment period has been extended from 2 years to 5 years as of June 2020. However, a portion of the loan is eligible for forgiveness.
The forgivable amount is the sum of the following costs incurred and payments made during the 8 or 24 week period:
- The loan proceeds are used to cover payroll costs;
- Most mortgage interest, rent, and utility costs over the 8 or 24 week period after the loan is made;
Full-time equivalent employee levels as well as compensation amounts must be maintained to prevent a decrease in forgiveness.
Here are the caveats:
- If you reduce your full-time employees (FTEs) from the average number of FTEs calculated from January 1, 2020, through February 29, 2020, your loan forgiveness will be reduced.
- If you decrease your salaries and wages by more than 25 percent for an employee that made less than $100,000 in 2019, your loan forgiveness will be reduced.
What if I have had to furlough or lay off employees? How does that affect my loan forgiveness?
You have until December 31st, 2020 to restore your full-time employment and salary levels for any changes made between February 15, 2020, and April 26, 2020.
Tax implications of your PPP loan
If governments create loan programs to support businesses, would those loans be considered gross income and subsequently taxable?
Generally, a loan is not included in the annual gross income of a business. But if a loan is forgiven, a portion or the entirety, the amount of the loan forgiven is included in the gross income of the business and is taxable. The exception to this would be an exclusion outlined in section 108 of the Internal Revenue Code or another Federal law applies.
The exception here is that The CARES Act elaborates that the forgiven loan amount won’t be included in taxable income. Meaning: you don’t pay taxes on the money that you receive.
The Internal Revenue Service later clarified: “This notice clarifies that no deduction is allowed under the Internal Revenue Code (Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136, 134 Stat. 281, 286-93 (March 27, 2020), and the income associated with the forgiveness is excluded from gross income for purposes of the Code pursuant to section 1106(i) of the CARES Act.”
What does this actually mean? Your PPP loan is forgiven if it is paying your payroll, rent, utilities, but those expenses typically are tax-deductible. If you forgo reporting your forgiven loan in your business’ taxable income, then you cannot deduct the aforementioned costs in your tax deductions because the loan has covered those expenses for the year.
This could mean that without the typical deduction of payroll, rent, utilities, your taxable income may not be lower, but higher, thus your business could pay more taxes than it does in a “normal” year.
Have more questions about PPP loans?
We still don’t know if this is the final form of the PPP loan’s tax implications. We could see legislation that clarifies the details of the PPP loan, maybe we will see more stimulus packages passed that create new economic programs and new regulations. This pandemic is not over, the total effects of the loans on the economy are still not clear, therefore the final answers are yet to be determined. We expect the IRS to clarify the tax realities before the filing deadline in 2021. Sound advice would be to plan on having a higher taxable income, to account for potential taxes owed.
When we know more, we will make sure we let you know too! If you have any additional questions regarding your business or PPP Loans, please schedule a consultation with us.