Many businesses are grappling, not only on how to fill out the PPP debt forgiveness forms, but also the timing of when they should be submitting to their financial institution. The timing of the debt forgiveness application could impact the amount of debt ultimately forgiven, financial statement reporting, and even the potential timing of when the expenses paid with PPP funds could be disallowed for tax purposes.
Deferment of Interest and Principal
Under the Paycheck Protection Program Flexibility Act, the number of months in which a lender is required to defer the principal and interest payments was expanded from 6 months to 10 months following the last day of the covered period. If the forgiveness application is approved prior to the 10-month deferral period, interest and principal payments will start earlier on the principal balance remaining after forgiveness.
For example, if a person received their PPP funding on April 22, 2020, their 8-week covered period would end on June 17, 2020, and their deferral of principal and interest payments would end on April 17, 2021.
If the same borrower chose a 24 week covered period, then the covered period would end on October 7, 2020, and the deferment of payment and interest would stop on August 2, 2021.
Provided the debt forgiveness application is submitted prior to the 10-month deferral period, the deferral will be extended to the date that the SBA remits the forgiveness amount to the bank or determines that the PPP loan is not eligible forgiveness (in whole or in part).
If the debt forgiveness application is not submitted by August 2, 2021, there is no longer any deferment and the borrower must begin paying principal and interest. The motivation to not pay any principal or interest payments on the PPP borrowed funds will cause many to apply for debt forgiveness prior to the 10-month deferral ending.
Financial Statement Impact
For business entities, the PPP loan will generally be treated as debt and accounting will follow ASC 470, Debt. The FASB ASC 470 debt model is appropriate for an entity that is not able to establish that it can meet a “no more than remote threshold” for repayment of the PPP loan due to uncertainties about meeting the conditions for forgiveness or eligible expenses. Under this approach, the extinguishment of debt may not take place until the debtor has been legally released as the primary obligor in accordance with FASB ASC 405-20.
As US GAAP requires liabilities to be classified as current vs. non-current based on the obligation to make payments on the liability, the expectation that a borrower will receive 100% forgiveness within 12 months does not trigger the need to classify the liability as current. Under GAAP, current vs. non-current is based on required payments, not anticipated forgiveness.
PPP borrowers who have not applied for forgiveness can take up to 24 weeks for their forgiveness period and then ten months after that to apply for forgiveness. No payments will be required until the end of the ten months. This timeline means that most clients with PPP loans cannot be obligated to make a payment until after June 30, 2021. Therefore, the case for classifying the PPP liability as a non-current liability is feasible for entities with a June 30th fiscal year-end. A December 31st year-end entity will most likely be required to classify the liability as current since the 10-month period will not extend beyond December 31, 2021.
Once a PPP borrower applies for forgiveness, they alter the timeline, and therefore classification would need to be revisited based on the specific facts and circumstances. A borrower’s intent to apply for forgiveness does not change the contractual timeline for when payments would be required. It’s only the actual act of applying that alters the timeline.
A second alternative may exist if a business entity can assert that there is no more than a remote probability that the business entity will be required to repay the loan, then an entity may analogize to ASC 958-605. This hurdle is rather high, as it would require that a client is able to demonstrate eligibility and meeting the conditions for forgiveness. While ASC 958-605 is a not-for-profit standard, business entities may analogize to this guidance.
Effect on the Amount of Debt Forgiveness if an Application is Submitted Before the Covered Period Ends
Businesses first need to understand if their PPP debt forgiveness will be affected by full-time equivalent (“FTE”) employee or salary reductions. The decision to apply prior to the covered period and utilize safe harbors will be drastically different depending on if there was an FTE or salary reduction.
The SBA guidance does allow a borrower to submit a loan forgiveness application before the end of the covered period if the borrower has used all of the loan proceeds for which the borrower is requesting forgiveness. However, as part of the debt forgiveness application, the number of FTE employees per month must be measured at specific dates, including:
- The lessor of average FTE employees during the testing period starting February 15, 2019, and ending on June 30, 2019, or January 1, 2020, and ending on February 29, 2020, compared to-
- FTE employees during the covered period.
Based on the original language, it would appear that the covered period, whether 8-weeks or 24 weeks, would have to end before an application could be submitted. This caused many businesses to be frustrated as their FTE count at the end of the 24 week covered period could be lower than earlier in the covered period if they depleted their PPP funding early.
For example, assume Company XYZ received PPP funding on 4/22/2020. The company chose to utilize the 24 week covered period. After week 13 all the PPP funds were utilized. Based on the initial language, XYZ would have to wait until the end of their 24 week period, October 7, 2020, before applying in order to calculate the appropriate FTE amount during the covered period. At the end of their 24 week period, their FTE may be lower than what existed on February 15, 2020, due to the fact that PPP funding was depleted at an earlier date.
This interpretation also made one of the FTE safe harbor tests harder to achieve. One of the FTE safe harbor tests allows the borrower not to reduce the amount of PPP debt forgiveness due to FTE reductions if:
- The borrower reduces its FTE employee levels in the period beginning February 15, 2020, and ending April 26, 2020; and
- The borrower then restores its FTE employee levels by the earlier of December 31, 2020, or the date the application is submitted to its FTE employee levels in the borrower’s pay period that included February 15, 2020.
If businesses were required to wait until the end of the covered period to submit applications, they would have to try to maintain the February 15, 2020, FTE count for the full 24 week covered period or plan to have the FTE count peak at the end of the covered period when most likely all PPP funds will be depleted.
While no formal SBA guidance has been issued, many banks reached out to the SBA for clarification surrounding the ability to calculate FTE’s prior to the end of the covered period. The SBA instructed the banks as follows:
- If a borrower uses the 24 week covered period, their FTE count and certification is NOT based on the full 24 weeks, but as of the time they completed using the funds for payroll. For example, if you complete using funds for payroll week 10, that is the end of the covered period for the purpose of FTE counts and related certifications.
Therefore, we highly encourage borrowers who are only impacted by an FTE reduction to work closely with their financial institutions and consider applying close to the time the business exhausted their PPP funding; if they are uncertain, they will be able to maintain their FTE count for the entire covered period.
On the other hand, if a borrower reduces an employee’s salary who made $100,000 or less in 2019 by more than 25% during the covered period, they will forfeit their ability to use the safe harbor surrounding salary reductions if they choose to apply before the covered period ends. The salary reduction safe harbor allows for the borrower not to reduce the amount of their debt forgiveness for such salary reductions if they have eliminated the salary reduction by the earlier of December 31, 2020, or the time in which they apply for debt forgiveness. However, if they apply before the end of the covered period the SBA guidance requires that the employee’s salaries who were reduced by more than 25% be extrapolated for the remainder of the covered period.
- Example: A borrower is using a 24 week covered period. This borrower reduced a full-time employee’s weekly salary from $1,000 per week during the reference period to $700 per week during the covered period. The employee continued to work on a full-time basis during the covered period, with an FTE of 1.0. In this case, the first $250 (25 percent of $1,000) is exempted from the loan forgiveness reduction. The borrower seeking forgiveness would list $1,200 as the salary/hourly wage reduction for that employee (the extra $50 weekly reduction multiplied by 24 weeks). If the borrower applies for forgiveness before the end of the covered period, it must account for the salary reduction for the full 24 week covered period (totaling $1,200).
Tax Impact of PPP Debt Forgiveness
While it is very clear under the CARES Act §1106(i) that any amount which would be includible in gross income due to PPP debt forgiveness is excluded from gross income, the IRS recently announced their position under Notice 2020-32 that the expenses paid with PPP funding that are ultimately forgiven are not allowed as deductions when calculating taxable income. When the Notice was released, many practitioners cited the weak authoritative guidance than an IRS Notice provides.
As explained by the Service, such notices are intended “to provide substantive or procedural guidance on an expedited basis with respect to matters of general interest that would otherwise be covered by a regulation, revenue ruling, or revenue procedure.” Notices are published without public comment in the Internal Revenue Bulletin. And while published notices can be relied upon by taxpayers to the same extent as revenue rulings or revenue procedures to avoid accuracy-related penalties, they do not have the force and effect of Treasury regulations and can be affected by subsequent legislation, regulations, revenue rulings, revenue procedures, and case law.
In addition, there is a thought process that both congressional intent and the wording of the statute referenced in Notice 2020-32 (IRC §265(a)(1)) do not support the Internal Revenue Service position. Key members of the Congressional tax-writing committees, including Senate Finance Committee Chair Chuck Grassley (R-IA), Ranking Member Ron Wyden (D-OR), and House Ways & Means Committee Chair Richard Neal (D-MA), sent a letter on May 5, 2020, to Treasury Secretary Mnuchin voicing their displeasure with IRS guidance on a CARES Act issue and requesting that the agency reverse this guidance.
Lastly, it has been recently noted that if lawmakers can reach an agreement on a smaller stimulus package, it could include a business provision that would allow a federal tax write-off for business expenses that were funded by PPP forgiven loans. However, just this week Senate Majority Leader Mitch McConnel expressed doubts whether Congress would be able to provide any additional pandemic relief package citing partisanship as the fall elections near.
For all of these reasons, businesses are analyzing whether they will allow expenses paid with PPP funding as deductions, at least for purposes of computing estimated tax payments.
Even if businesses choose to follow Notice 2020-23 and disallow deductions for expenses paid with PPP funding that is ultimately forgiven, there may be a potential timing benefit for cash-basis taxpayers who chose to apply for debt forgiveness in the 2021 taxable year.
Every business's circumstance is different and the variety of implications applying for debt forgiveness can have on a business makes the decision more challenging. Please do not hesitate to reach out to The Bonadio CARES & More Consulting Team for additional support and guidance throughout this process.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute an accountant-client relationship.