PPP Loans: Frenetic Fixes and Forgiveness

The rules related to Payroll Protection Program (“PPP”) loans confuse most of us. Candidly, the federal government has tried to protect small business, but the legislation and guidance have been unable to predict the severity of the virus or of the need. Two major Acts (the CARES Act and the Paycheck Protection Program Flexibility (PPPF) Act) provide the underlying authority and the funding to the SBA to make PPP loans. In addition, another Act just signed on Independence Day extends the deadline for applications until August 8, 2020.

The PPPF Act was made effective retroactively to March 27, 2020 and made extensive changes to the PPP. Among the PPPF Act improvements, employers who receive PPP loans (“Borrowers”) are allowed until December 31, 2020 to qualify for loan forgiveness instead of June 30, 2020. Loan proceeds may now be used 24 instead of eight weeks (although a Borrower receiving its loan before June 5, 2020 may select the eight week period) The new rules have also decreased the percentage of the proceeds that must be used on payroll costs from 75% to 60%. This change results in an increase in the loan proceeds that may be used for non-payroll costs from 25% to 40%.

A Borrower may have its PPP loan forgiven based on certain costs incurred and payments made (“Eligible Payments) within its “Relevant Period.” Eligible Payments include payroll costs, covered utility and rent payments, and interest (but not principal) on certain mortgages. Generally, to prevent padding, the arrangements that result in Eligible Payments have to have been in existence before February 15, 2020.

With the PPPF Act changes, the Relevant Period becomes more complex. Generally, the Relevant Period is the 24 weeks beginning on the PPP loan closing date (but ending no later than December 31, 2020). If such closing date was before June 5, 2020, the Borrower may elect the old eight-week period. If no election is made, the 24-week period applies, and the Borrower has to maintain its payroll at the required levels for the 24 weeks to be eligible for PPP loan forgiveness.

The Borrower who proves that it has expended the loan proceeds on Eligible Payments and who timely requests forgiveness for its loan can have its loan forgiven. Generally, forgiveness of debt causes commensurate gross income for federal income tax purposes. However, PPP loan forgiveness receives a full exemption from these rules. Thus, PPP loan forgiveness does not result in gross income or even in a reduction in tax attributes of the Borrower (no reduction in NOLs, credits, carryovers, and tax basis).

The IRS has taken the position that expenses paid with forgiven PPP loan proceeds are non-deductible. The IRS argues that forgiven PPP loans are tax-exempt income. Many have criticized the IRS’s position contending that the IRS has missed the fundamental relief intended (including tax relief) when forgiveness is granted. Congress may overrule the IRS’s position through legislation.

This controversy is far from academic. Assume that the Borrower received a PPP loan of $1MM, which is forgiven, and used it to pay Eligible Expenses. Also assume that the Eligible Expenses would have been deductible in a flat 20% tax bracket except for the IRS’s position. The Borrower has lost $200,000 of relief. Alternatively, assume the Borrower’s taxable income before the deduction in controversy was less than $1MM, and thus, the Borrower could not deduct all or part of the Eligible Expenses currently. The Borrower still has its NOL reduced and full relief is lost.

This article illustrates how quickly this area of the law is changing. If you are interested in these rules, please consult a competent advisor for the latest guidance.