In hopes of supplying liquidity to struggling businesses, the Paycheck Protection Program (PPP) was established under the Coronavirus Aid, Relief and Economic Security Act (Cares Act) to provide eligible businesses a loan to pay expenses such as: payroll cost of up to $100,000 per employee; benefits, including vacation and parental, family, medical, or sick leave; state and local taxes on compensation; utilities; rent; mortgage interest; and interest on existing debt.
An added benefit of the program allows businesses to receive forgiveness for any part of PPP loan indebtedness used to pay payroll costs, mortgage interest, rent, and utilities. As originally written, forgiveness could be obtained for amounts paid within 8 weeks from the loan's origination date (the "covered period"). On June 5, the president signed an amendment to the PPP, entitled the Paycheck Protection Flexibility Act (PPFA), allowing current borrowers the option of extending the covered period for existing loans from eight to 24 weeks and providing that the covered period for new loans is now 24 weeks.
Although the amount of the loan forgiveness is affected if a business reduces its total number of full-time employees over the covered period or their wages by more than 25 percent, the Cares Act specifically provides that the amount of the loan forgiveness is exempt from federal income taxes. Additionally, as originally written, the PPP provided that in order to obtain maximum loan forgiveness, at least 75 percent of the PPP loan proceeds needed to be used for payroll expenses. The PPFA amended this provision to mandate that a borrower must expend 60 percent of PPP loan proceeds on payroll costs in order to obtain loan forgiveness. This change allows borrowers to direct more funds to costs such as rent, utilities, and interest.
Businesses were first allowed to apply for a loan under the PPP on April 3, 2020. As a result of its popularity, 4,470,116 loans have been approved, with an average loan size of $114,144, as of May 29, 2020. As businesses that participated in the PPP reach the expiration of the covered period as originally intended, they must contemplate a few issues.
First, the Cares Act requires that a PPP participant apply to their lender for loan forgiveness at the end of the covered period. The SBA, in consultation with the IRS, has released an application for PPP loan forgiveness along with instructions. The form and instructions provide details on applying for and calculating the amount of PPP loan forgiveness.
Second, on April 30, the IRS issued proposed guidance (IRS Notice 2020-32) stating that taxpayers are not permitted to deduct expenses on their tax returns to the extent those amounts are paid or reimbursed by a PPP loan that is later forgiven. As noted, expenses subject to forgiveness under the PPP include payroll costs, mortgage interest, rent, and utilities. They don't, however, include interest on existing non-mortgage debt obligations. The proceeds of a PPP loan can be used to pay this type of interest, but it is not subject to forgiveness.
The Cares Act did, however, provide some tax relief regarding this situation. In 2017, the Tax Cuts and Jobs Act (TCJA) reduced the amount a business entity can deduct for interest expense to 30 percent of its adjusted taxable income (ATI). Prior to that time, the interest expense deduction had no significant restrictions. The Cares Act raises the limit on the business interest deduction from 30 percent of ATI to 50 percent of ATI for the 2019 and 2020 tax years. In addition to receiving a larger than expected interest deduction for 2020, a business may amend its 2019 tax return to deduct additional interest in order to receive a refund of tax.
Because there can be subtleties involving the timing and nature of the amounts subject to forgiveness under the PPP and the associated tax impacts, it is strongly recommended that businesses seek professional advice if they have chosen to participate in the program.