When the Covid-19 pandemic began in early 2020, no one knew the large-scale effects it would have on businesses, the economy, and everyday lifestyles.
One of the major pieces of legislation passed as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was the Paycheck Protection Program (PPP). These loans were offered to qualified small businesses and nonprofit organizations to help them navigate the economic uncertainty of the early pandemic while still paying their employees.
Many organizations are now finished spending their PPP funds and looking forward to what’s next. This article looks ahead for businesses and organizations operating in a swiftly changing business landscape, addresses PPP forgiveness, and highlights some recent legislation and regulations that will impact the coming months and years.
Business Operations in an Unpredictable World
With so much disruption in so many industries and aspects of business, planning for future operations can be a daunting task. Throw in the new government business incentive programs with the related uncertainties and it can seem impossible.
The new, and sometimes not well understood, incentive programs, like the PPP, present opportunities and pitfalls for organizations that take part in them. Most organizations benefit by focusing on making decisions that make the most sense from an operations standpoint, even if that means not maximizing an incentive program like the PPP or the refundable payroll tax credits.
By running your business or organization to maximize its effectiveness and profitability first, you will be in no worse condition than you would have been if the incentive program didn’t exist. This doesn’t mean that incentive programs should be ignored.
As always, organizations need to plan and act on what makes the most business sense, then weigh and integrate the incentive programs to move the strategy forward. Preparation, planning, and research are key.
Planning for the Unexpected
The businesses that are able to plan and effectively manage their cash flows during these unprecedented times will be well positioned for a quicker recovery and may also be able to capture market share from their less-prepared competitors.
Proper financial planning and analysis can not only help businesses survive the downturn, but also empower business leaders to make better-informed decisions regarding growth initiatives, cost/expense controls, staffing decisions, investments in capital expenditures, and financing, among other key financial decisions—not only during these times, but as a best practice in any environment.
One crucial aspect of sound financial planning and analysis is to consider a variety of potential outcomes (not only a “most likely” scenario—which is a good start—but also alternatively, less likely scenarios that could push your business to its limits).
Much of this can be illustrated through a scenario-based cash flow modeling exercise, in which the impact from a variety of outcomes—e.g., how customers, employees, and the economy as a whole are able to cope with and recover from the challenges brought about by the pandemic—can be estimated in terms of cash flow.
For those businesses that have received PPP loans, and specifically loans in excess of $2 million, it is probably in your best interest to be proactive in terms of scenario planning and documenting scenarios that support the need for the PPP funding, in connection with the need certification required by the Small Business Administration (SBA).
The SBA continues to develop procedures and forms related to organization’s certification of economic need from the original PPP loan application. There are forms circulating online specifically related to this. However, as of Nov.19, 2020, the SBA has not released new official information on their website related to the upcoming audits of the needs certification. While the no official information has been released, there is expectation that additional guidance will be published related to this area and borrowers should consider preparing ahead of time. Preparing a document that discusses the economic condition and outlook of the organization at the time of application for the PPP may be strengthened through financial modeling and should be considered as part of a well prepared loan file.
PPP Loan Forgiveness
The Paycheck Protection Program Flexibility Act was signed into law on June 5, 2020. It provided a new set of rules that impact forgiveness and is a positive development because most borrowers should now be seeking close to (if not 100%) forgiveness. This is due to the flexibility of when and how to file for forgiveness.
In addition, the application is not a simple check-the-box form. For those that do not qualify for the EZ application, the actual calculation and supporting documentation requirements present a daunting task and can be extremely time consuming.
But even for those filing an EZ application, the documentation supporting the business certifications will need to be gathered, analyzed, and maintained.
The most time-consuming part of the entire standard application is on the Schedule A worksheet. This is where borrowers list out every employee that was employed during the loan period.
The borrowers have to split the employees into two groups: The first being any employee making over $100,000 on an annualized basis during any pay period in 2019, and the second being all other employees (apart from owners).
This allocation of employees forces borrowers to comb through all of their 2019 payroll files to ensure that any employee making more than $1,923 in any given week is flagged and listed on the correct table on the schedule A worksheet.
Just as everyone started to get a handle on how forgiveness was going to work and were ready to move forward, the waiting game started over as applicants awaited the time when lenders and the SBA would start taking applications.
On Aug. 10, 2020, the SBA officially opened up their portal to begin accepting applications; however, many lenders were not ready to start processing and submitting the SBA applications and continued to work through their internal platforms while waiting for further guidance from the SBA.
Entities Welcome Guidance on How to Account For PPP Loans
Once forgiveness is applied, another accounting aspect of how to record the loan and its forgiveness on financial records moves front and center. The expedited way in which the PPP was developed led businesses to have questions related to many aspects of the program.
Among those areas was how to actually account for the loan proceeds once they were received. Not surprisingly, U.S. GAAP contains no specific guidance on the accounting related to forgivable debt provided by a government entity.
Fortunately, the American Institute of Certified Public Accountants (AICPA) collaborated with Financial Accounting Standards Board (FASB) staff to develop non-authoritative guidance in the form of TQA 3200.18, Borrower Accounting for a Forgivable Loan Received under the Small Business Administration Paycheck Protection Program.
This TQA provides non-governmental entities with several approaches that are acceptable to use when accounting for PPP loan proceeds along with the related forgiveness. There are two outcomes for accounting for the PPP. One holds the balance of the loan as debt until the outcome is known (forgiveness or paying back the debt). The other writes down the loan as qualified expenses are incurred.
The first option is to account for the proceeds as debt. In this scenario, the loan is reflected as a liability of the entity and interest is accrued in accordance with the loan terms until such time as the debt has been legally forgiven by the SBA or repaid by the borrower.
Another available option under the TQA, which results in a similar outcome for recognition of loan forgiveness, is to utilize the available guidance on gain contingencies.
Other approaches provided by the TQA utilize guidance from international standards as well as the rules related to conditional contributions that were originally intended for use by not-for-profit entities.
The use of either of these approaches may allow an entity to recognize a reduction in the PPP loan liability prior to formal forgiveness if certain criteria are met. The full text of the TQA provides additional details regarding the timing of this income recognition.
These latter two approaches are generally considered more complex, so borrowers should consult with their CPA prior to year-end so that any unique issues can be discussed. While the multiple options that exist can add complexity to accounting for the PPP loan proceeds, they also provide entities with more flexibility than is typically seen in U.S. GAAP.
The Potential Tax Impact of PPP Loan Forgiveness
Now we have forgiveness, and multiple ways to account for it, but what about the tax impact? Section 1106(i) of the CARES Act provides that any amount that would be includible in gross income of the recipient by reason of forgiveness of a PPP loan “shall be excluded from gross income.”
Thus, the CARES Act excludes from the gross income of a borrower any income that may arise from PPP loan forgiveness, regardless of whether such income would otherwise be properly characterized as income from the discharge of indebtedness.
In Notice 2020-32, the Internal Revenue Service addressed the effect of PPP loan forgiveness on the deductibility of payments of eligible expenses made with forgiven funds. In the notice, the IRS applied tax code Section 265 to expenses paid with PPP proceeds.
This provision provides that no deduction is allowed to a taxpayer for any amount that is allocable to one or more classes of tax-exempt income.
The IRS concluded that to the extent that Section 1106(i) of the CARES Act operates to exclude from gross income the amount of a PPP loan, Section 265(a)(1) disallows any otherwise allowable deduction for the amount of any payment of an eligible expense to the extent of the resulting PPP loan forgiveness (up to the aggregate amount forgiven) because such payment is allocable to tax-exempt income.
Thus, if a taxpayer paid $80,000 of otherwise deductible expenses with PPP proceeds that were subsequently forgiven, while the forgiveness would not trigger $80,000 of taxable income, the borrower would be denied a tax deduction for the $80,000 of expenses paid.
The IRS recently confirmed in Revenue Ruling 2020-27 that regardless of when an application for forgiveness is submitted to the SBA (in 2020 or 2021) if at the end of the 2020 tax year, the borrower “reasonably expects” that forgiveness will be granted, the borrower may not deduct the expenses paid with the PPP proceeds on the 2020 tax return. If, however, the taxpayer receives a decision on forgiveness prior to filing a timely 2020 tax return and part or all of the forgiveness is denied, Revenue Procedure 2020-51 allows the taxpayer to deduct the allowable expenses on the 2020 return.
As of the time of this writing, members of Congress remain determined to overrule the IRS by adding to future legislation the requirement that expenses paid with forgiven PPP funds be fully deductible.
In summary, many organizations have spent their PPP funds and looking towards the future. Recent regulations, new legislation, PPP forgiveness rules and the ever-changing landscape are sure to keep businesses guessing as to what comes next.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Brandon Loeschner, CPA, CISA, CGMA, is a partner in St. Louis; Tony Nitti, CPA, MST, is a partner in Denver; Jeff Sparks, CPA CGMA, is a partner in St. Louis; Rhonda Sparlin, CPA, is a partner in Denver; Ted Clifton, CPA, is in the Denver office; Aaron Pollard, CPA, CGMA, is a partner in St. Louis; Tim Farquhar, CFA, CPA, is a partner in St. Louis; and David Duckwitz, CPA, is in the Kansas City office of Rubin Brown.
To stay up-to-date on the latest Covid-19 tax, consulting, and business advisory news visit www.RubinBrown.com/COVID19.