Wow! Can you believe it’s been over 15 months since the CARES Act was passed? We know that some of you are saying it feels even longer. Besides the actual pandemic and the resulting government restrictions, you’ve had to deal with several major Congressional relief acts, ever changing guidance from Treasury and the SBA, and over two dozen LSL blog posts. (We know. Part XVI. But we didn’t start counting until May 2020.)
All through the pandemic we have been advising patience. And, in great measure, it has paid off. After many difficult months, we received a lot of good news from Washington in December. We still feel that Congress intended Treasury and the SBA to be a bit more generous with small businesses than they have been. But, as you will see below, we’ve certainly been moving in the right direction.
You may apply for PPP loan forgiveness up until the maturity date of the loan. This is at least two years after funding. However, payments may start 10 months after the end of your covered period. Your loan documents may say something different, but as of June 2020, Congress granted all borrowers the option of a 24-week covered period and extended the payment deferral to not less than 10 months beyond that. A careful reading of the law indicates that banks may defer payments even longer. Most seem to be pushing the payment due date forward to the first of the following month. We have not heard of any bank exercising their discretion and extending the start of payments beyond that.
If your loan funded on the first day of the program, 4/3/2020, your covered period would end 9/17/2020 and your loan forgiveness application would be due on 7/17/2021. If your loan funded on or after 4/17/2020, your loan forgiveness application is not due until at least 8/1/2021.
This deadline is for you to submit your loan forgiveness application to your bank. It is not the bank’s deadline to submit to the SBA, which is 60 days later. After that, the SBA is supposed to act on your application within 90 days, unfortunately it has been taking longer, especially for larger loans.
When you submit your loan forgiveness application within 10 months after the end of your covered period, no payments will be due until the SBA makes a final decision on your application. This is true even if a payment is scheduled for the next day.
You will want to double check your date calculations. If your covered period starts on a Wednesday, it ends on a Tuesday. And, as mentioned above, your bank might schedule your first payment a few weeks after your deadline to submit your loan forgiveness application and defer all payments. In other words, the date of your first payment is not your deadline to apply for forgiveness. That deadline will be earlier than your payment date.
AB 80 Did Not Solve All of Your Tax Issues
We will dive deeper into loan forgiveness shortly. But, first let’s talk about your income tax deadlines.
In December 2020, Congress reiterated that small businesses should not suffer any adverse tax consequences from their PPP loans or PPP loan forgiveness. The IRS acquiesced. Except for some tax basis timing issues, the federal tax issues are generally settled.
California, not so much. As we discussed in May, AB 80 added very little certainty to the taxation of PPP loans in California. If you were qualified to receive a second PPP loan, whether or not you received one, then California will not tax your PPP loan forgiveness. However, if you didn’t have a 25% gross receipts reduction for a calendar quarter in 2020 compared to the same quarter in 2019, AB 1577 will govern how your PPP loan is taxed. AB 1577 only applies if AB 80 doesn’t.
In our opinion, last year’s AB 1577 also adds little certainty. If you received your PPP loan funds in the same tax year as you applied for forgiveness, then your PPP loan forgiveness is taxable for California. This is done by reducing your expenses by the amount paid with forgiven loan funds. The loan forgiveness is not included in gross income.
So, what happens if you apply for forgiveness in 2021 and you received your loan funds in 2020? According to the California Franchise Tax Board, there’s no difference. You should reduce your 2020 deductions for amounts paid with PPP loan funds that might, at some point in the future, be forgiven. We respectfully disagree. The FTB’s analysis is based on a rescinded IRS notice. In addition, a careful reading of AB 1577 seems to imply that the expense disallowance is only triggered if the funding and forgiveness occur in the same tax year.
A majority of states do not tax PPP loans. California is among the other 21. With California’s V -shaped recovery and resulting budget surplus, it’s unclear why the California legislature is insistent on taking pandemic relief funds away from small businesses. Perhaps with the looming Gann state spending limit, the legislature will revisit the issue. We can only hope.
The Loan Forgiveness Application and Possible 11th Hour Changes
First the good news: Assuming you spent the majority of your loan funds on paying your employees, Congress wants your loan to be forgiven. To that end, every pandemic response act has made it easier to obtain full forgiveness: the covered period has been lengthened; the list of forgivable expenses has been expanded; and additional safe harbors from the limitations on forgiveness have been created. And while Treasury and the SBA have seemingly sometimes been stricter than Congress intended, they too have been attempting to streamline the originally quite onerous forgiveness application. New forms have been created; the need for limitation calculations has been reduced; even the SBA website has been redesigned to be more borrower friendly. In addition, the AICPA reported last week that the SBA is likely to drop the necessity questionnaire and increase the loan limit for the simplified forgiveness procedures.
So, what’s the bad news? At this, the 11th hour, the banks will have a hard time keeping up. Actually, we’re sure that the banks’ IT departments would call it the 12th hour. Other than giving them your sympathy, what can you do? You should visit the SBA’s loan forgiveness page and read the three loan forgiveness application forms (3508, 3508EZ, and 3508S) and their instructions. We will talk about safe harbors shortly. If you qualify for a safe harbor or can check a box to skip the limitation calculations, you will need to contact your banker. The SBA doesn’t want to review unnecessary limitation calculations any more than you want to prepare them.
Nearly all the clients that we’ve talked to meet one or more of the safe harbors. That’s not surprising since contrary to many sensational news stories, most businesses did in fact use their PPP funds to pay their employees.
The 3508EZ lives up to its name. In order to use it, you must meet a safe harbor for both limitations, the pay rate limitation and the employment level (FTE) limitation. To avoid the pay rate limitation, you must not have reduced the base salary or hourly rate of any employee by more than 25%, or if you did, you must have restored the rate by 12/31/2020. To avoid the employment level limitation, you must not have reduced headcount or hours compared to pre-pandemic levels, or again, you must have restored it by 12/31/2020. Alternatively, you may show that the employment level reduction that remains is because of government restrictions or market conditions outside of your control, again through 12/31/2020. In our experience, virtually all our California clients will qualify to use the 3508EZ application.
Do you want more good news? Both Congress and the SBA have expanded the expenses that are eligible for forgiveness. But as you would expect, there are many unanswered questions. Covered essential supplier costs are particularly problematic. The bottom line here is that the 60% payroll cost requirement is the real forgiveness limitation. If you meet that requirement, you will most likely get full forgiveness.
You only get one shot at your loan forgiveness. For that reason, even if you think you meet a safe harbor, you should include the full 24-weeks of payroll and non-payroll expenses on your application. Just remember to reduce your expense amounts by any other credits or government grants. This will protect your forgiveness amount if a limitation is later applied.
One More Wrinkle: The Employee Retention Credit
In December, Congress greatly expanded the Employee Retention Credit. There are many unknowns, and the IRS has taken a relatively narrow view of which businesses qualify for the credit. In addition, the deadline for amended payroll tax returns is at least two years away. So, there’s no need to worry about the hard cases yet.
Still, since the credit can be up to $5,000 per employee, we advise you to keep your options open.
It’s not too difficult to do. First, as we advised above, include all your eligible payroll and non-payroll costs on your loan forgiveness application. Currently, the IRS will allow an ERC claim to be made on payroll amounts that are shown on a loan forgiveness application but are not necessary for full forgiveness. This was not always the case. So, second, when you have sufficient payroll costs, consider reserving up to $10,000 in wages per employee on your loan forgiveness application for a potential future ERC claim.
We thank you for making it all the way through this extra-long post!
As always, if you have questions about your specific situation, please don’t hesitate to contact your LSL partner or team member.
Happy Fourth of July!