It’s hard to believe that it was just eight months ago that the Paycheck Protection Program was born. Signed into law as an element of the CARES Act on March 27, 2020, this program has been both a lifesaving cash infusion and a headache inducing number-crunching exercise for many providers.
At this point, most borrowers have completed their 24-week forgiveness period and are seriously considering forgiveness; many have already submitted forgiveness applications. Regardless of where you are in the forgiveness process, here are four key items to consider right now specific to PPP:
1. Income Taxes
For months now, we have known that while the income received via the PPP program was specifically exempt from taxation, the Internal Revenue Service was taking the position that expenses claimed as support for PPP forgiveness would not be deductible for taxable entities. (Note that this is not an issue for entities that are otherwise tax-exempt.) Taxable providers were considering a number of different approaches to tax planning to address the income tax effect of this treatment. One more commonly considered approach was to wait until 2021 to apply for forgiveness on the theory that doing so would delay the income tax impact by a year as a 2021 event instead of a 2020 event.
On November 18, the IRS provided clarification on the Paycheck Protection Program (PPP) and taxability. The IRS clarified through Rev Rule 2020-27 that the timing of the debt relief application being filed by the taxpayer is irrelevant for taxpayers in determining the timing of the disallowance of expenses incurred in 2020 if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.
This means that for most taxpayers, the income tax impact of the inability to deduct expenses claimed to support PPP forgiveness will be a tax item for the 2020 tax year regardless of when the actual forgiveness application is submitted or decided upon.
Timing matters not only because deferring a tax for a year is generally good for cash flow. Specific to 2020, there is an overall drive to push more (deductible) expenses into 2020 because of a separate provision of the CARES Act. If a net operating loss is generated in the 2020 tax year, under the CARES Act the taxpayer is allowed to carry the net operating loss back five years and forward indefinitely and not be subject to an income limitation. The ability to carryback the loss five years generally allows a higher effective tax rate to be offset and therefore has a more significant cash impact. However, if a loss is generated in 2021 there is no carryback allowed at the federal level, and the loss can be carried forward indefinitely but can only offset 80 percent of taxable income.
There are numerous potential implications to this for taxable providers depending on your structure and other elements of your financial results. Our Partner, Lynn Mucenski-Keck, wrote an article that goes into more detail on this issue that can be accessed on our website here.
2. The “Double Dip”
There are literally dozens of aid programs in the CARES Act. Many providers have benefited from more than one program created by the Act to address the COVID-19 disruption. Most notably these include PPP, but also Department of Health and Human Services Provider Relief Funds, FEMA Disaster Relief Grants, and others. This is on top of funding programs from State-level, local, and private sources, some of which may only be available to not-for-profit providers.
As providers crunch the numbers of PPP forgiveness, it is critical to identify a cross-over between the expenditures allowed to be claimed against these various funding sources and manage the risk of claiming the same dollar of expenditure against more than one funding source. This phenomenon often referred to as “double-dipping,” is a risk because federal regulations prohibit claiming a single expenditure as support for more than one federal source of funds.
Many state funding streams also prohibit double dipping through the use of language indicating that they are “the funder of last resort.” This means that if an expenditure was covered by another funding source, the funder claiming to be the funder of last resort will not cover that expenditure. For example, if you have a grant that funds specific positions as part of its budget, can you also claim the payroll cost of those positions as support for your PPP forgiveness?
It is entirely possible that a provider could face the choice of repaying one funding source or another to the extent that eligible expenses cannot be claimed against both. Consideration of the terms under which these repayments might happen and how that could impact your long-term relationships with the various funders should be thought out before the PPP forgiveness application is submitted. In some cases, it may be better to take full PPP forgiveness and repay another funding source when a double-dip situation is identified, but these decisions need to be made on a case-by-case basis.
Understanding the positioning of your funders, including both COVID-19 related funding and traditional recurring operational funding, is critical to avoid the double-dip and maximize the overall total of supportable claims on the various available funding sources. It is advisable to carefully consider this before submitting your PPP forgiveness application. A borrower only gets one chance to submit a PPP forgiveness application.
3. Timing
At this time, most lenders have opened their portals for PPP loan forgiveness applications. But should you submit your forgiveness application right away or wait? Remember, PPP borrowers are allowed to utilize the funds over a forgiveness period of as long as 24 weeks. Forgiveness applications can be submitted at any time up to ten months after the end of the forgiveness period. No one can compel you to apply for forgiveness before the last day of the ten-month period.
We are finding that many providers are preparing for forgiveness but waiting to submit. Why wait? Some providers are hopeful a new federal stimulus bill will be passed that creates a streamlined forgiveness process that will ultimately be easier. Others are hoping for clarity on the double-dip question that reduces the overall double-dip risk. Still, others fear that whatever they submit with their forgiveness application is likely to become publicly available through the SBA at some point and are hoping for relief from some of the information requirements.
We point out that hope is not a plan. And there is always the chance that changes could be made to the program to make forgiveness more difficult, although we think the risk of that is fairly low.
The case for waiting is simple: There is essentially no cost to waiting. A borrower cannot be compelled to make a payment of any kind until forgiveness is applied for and a forgiveness decision is handed down by the lender and the SBA. If forgiveness is ultimately achieved, any interest accrued on the loan will also be forgiven. To the extent that only partial forgiveness is expected, waiting defers payments. For borrowers anticipating full forgiveness, no payments will ever be required, so the timing of the forgiveness application doesn’t really matter from a cash flow perspective.
We can’t say that waiting to apply for forgiveness will ultimately be beneficial. But if waiting offers the chance for a better answer or some form of reduced risk at what amounts to no cost, why not wait?
4. GAAP Accounting and Earnings Management
The question of when does a PPP borrower get to record the income for forgiveness on their GAAP-basis financial statements is more complicated than you might think. Every borrower should talk to their CPA about the right path for recognizing the income for their organization.
There are choices. Most for-profit providers will choose option 1, while most not-for-profit providers will choose option 2.
Articulating this is a choice between two options is an oversimplification. There are details behind each of these options and there may even be other options in some narrow circumstances. If you are into the technical details, I recommend an article by our Partner, Justin Reid, on our website here.
For many providers, the flexibility afforded by these options presents an unusual opportunity for earnings management. By earnings management, we mean there is the opportunity for management to choose a path for PPP accounting based on what produces the desired bottom-line result for the reporting period instead of what might be considered the most technically correct treatment.
As an auditor, I can tell you that auditors don’t typically like earnings management situations. Providers should be aware of when they are engaging in conversations that sound like earnings management. In those cases, providers should involve their external auditors early in those conversations so that surprises do not pop up after year-end when the auditors look at the numbers. It may seem like a great idea to record PPP income right away, but if the motivation for doing so is that it’s the only way you can report results in compliance with your existing debt covenants, your auditor and/or lender could be interested in that decision.
An additional element here is communication with owners and/or Boards of Directors. To the extent an accounting choice will have a material impact on the provider’s financial position and results, those charged with governance should understand the choices and the impact of the decision, including benefits and risks.
Wherever you are on your PPP journey, don’t be shy about getting professional help. This article is just an overview of four common areas of discussion that arise with PPP borrowers. There are a lot of details and it can’t hurt to talk it through with a member of our team who has been specializing in this stuff since it all started eight months ago. Please contact our experts today to learn more and discuss your specific situation.
The information and advice we are providing for this matter relates to COVID-19 legislative relief measures. Because legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that could modify some of the advice and information provided to you, after the conclusion of our engagement. We, therefore, make no warranties, expressed or implied, on the services provided hereunder.