By Greg Yoder
UPDATE: The SBA has extended the repayment date under the Safe Harbor to May 18, 2020, to give borrowers an opportunity to review SBA’s new guidance.
The Paycheck Protection Program (PPP) and the loans it provides continue to be the most important financial assistance programs for many small and mid-sized businesses during the current pandemic. As you likely already know, Congress created the PPP as part of the CARES Act in response to COVID-19. When businesses quickly borrowed all of the funds provided in the initial law, Congress passed additional legislation, primarily to further fund the PPP loan provisions.
Many businesses, including many of our clients, have applied for and received paycheck protection loans. Provided that businesses follow the CARES provisions, these loans do not have to be repaid, and the debt forgiveness is not considered taxable income, making the loans a major tax benefit, as well as a vital economic one.
Following the CARES provisions, however, has been complicated for many taxpayers, and the Small Business Administration (SBA), which administers the program, has been giving additional guidance at frequent intervals. This has mostly taken the form of a FAQ. For those who are interested, the most current version of SBA’s PPP FAQ (it’s all TLAs all the time these days) can be found at https://www.sba.gov/document/support–faq-lenders-borrowers.
We wanted to highlight two important updates affecting PPP loans.
Safe Harbor for Loans under $2 Million
One of the certifications that borrowers have to make when applying for a PPP loan is that they really need the loan to succeed in the face of COVID-related economic troubles. Or, in the language of the SBA, that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
In guidance issued May 13, SBA says that for loans of less than $2 million, if the borrower makes such a certification, the borrower “will be deemed to have made the required certification concerning the necessity of the loan request in good faith.” This safe harbor is important because it means that when banks and other lenders receive a loan application with this certification, they don’t have to do any additional procedures or request additional documentation to ensure that they’re complying with SBA requirements on this issue. This in turn means that they’re eligible for the loan guarantees provided under CARES and should be able to loan money more quickly and with more confidence. Borrowers — who are already having to provide substantial amounts of information to document payroll costs and other items — are relieved from the burden of having to provide yet more information to qualify for loans. It’s one less hoop for businesses that are already jumping through a lot of them while trying to stay afloat.
Non-deductibility of Costs Funded by PPP Loans
CARES specifies that (if all requirements are met) PPP loans can be forgiven and that the loan forgiveness does not have to be treated as taxable income by the taxpayer. This is a substantial tax benefit since under general tax provisions, loan forgiveness is treated as taxable income. In order to meet the loan forgiveness requirements, businesses have to use the funds to pay expenses that would normally be deductible as ordinary and necessary business expenses. Since the legislation didn’t specifically say that the expenses paid with the excludable loan proceeds would be non-deductible, some financial experts speculated (hoped, really) that taxpayers would get a double tax benefit. In other words, there had been some hopes that a business could take out a PPP loan, use it to pay salaries (for example), not repay the loan, not include the loan forgiveness as income, and still deduct the salaries as expenses on their 2020 tax returns.
Most of us thought that level of generosity was unlikely (and unintended), and the IRS agreed. In Notice 2020-32, IRS says that amounts paid with excludable PPP funds are not deductible for income tax purposes. The reasoning that IRS used to reach this result was arguable (trust me when I tell you that you don’t want to know the details), but the result itself makes sense under tax law.
As always, we continue to monitor these and other developments, and we will continue to update you as the situation evolves, which it certainly will.