January 08, 2021
On December 27, 2020, the President signed into law the Tax Relief Act, as part of H.R. 133, referred to as the Consolidated Appropriations Act of 2021 (the "Act"). Of note, the Act enhances and expands certain provisions of the CARES Act, and makes particular changes to the Paycheck Protection Program (PPP) and Employee Retention Tax Credit.
Expenses Paid with Forgiven PPP Loan Funds Now Fully Deductible
As part of the original CARES Act, Congress specified that the proceeds of forgiven PPP loans would be excluded from recognition in a recipient’s gross income. In absence of specific directions to the contrary, the IRS subsequently issued Notice 2020-32 and Rev. Rul. 2020-27, taking the position that all corresponding expenses paid with forgiven PPP loans proceeds would therefore not be deductible. Understandably, this position drew considerable criticism, and, as part of the Act, Congress has explicitly clarified that expenses paid from forgiven PPP loan funds will be deductible for federal income tax purposes.
The new law also states that that no tax benefit shall be denied, and no loss carryovers or basis adjustment will be required, as a result of the tax-free forgiveness of a PPP loan. For pass-through entities (e.g., LLCs or S corporations), forgiven loan amounts will also result in an increase in the basis of any owner’s interest in the entity, which will preserve the economic benefit of a forgiven loan by preventing later taxation when distributions are made or such ownership interests are sold.
Extension and Changes to the PPP Loan Program; Simplified Forgiveness for Small Loans
For first-time borrowers, the deadline to apply for a PPP loan has been extended to March 31, 2021, following the same qualifications, rules and guidance established since the passage of the original CARES Act. The Act also directs the SBA to create a simplified application for PPP loans of $150,000 or less. Loans not exceeding more than $150,000 will be forgiven if the eligible recipient signs and submits to the lender a certification that includes: (1) a description of the number of employees the eligible recipient was able to retain because of the PPP loan; (2) the estimated amount of the covered loan amount spent by the eligible recipient on payroll costs; and (3) the total loan value. Eligible recipients of these small loans are not required to submit any documentation in addition to the certification and information required to substantiate forgiveness.
The act also repeals the requirement that PPP borrowers must deduct the amount of any Economic Injury Disaster Loan (EIDL) advance from their PPP loan forgiveness amount. Now, total PPP forgiveness should not be reduced due to the EIDL advance. The effective date for this change dates back to the enactment of the CARES Act.
Second Draw PPP Loans
The Act creates a second loan from the PPP – called a “PPP second draw” loan -- for smaller and harder-hit businesses who have previously received a PPP loan. In order to be eligible for a PPP second draw, eligible entities must:
- Employ 300 employees or less (down from 500 employees for first round PPP loans). Borrowers must still apply the SBA affiliation rules when counting total employees. However, businesses in the food service and hospitality sector (NAICS Code 72) are still exempt from the affiliation rules, and, similar to the initial PPP requirements, such entities may employ not more than 300 employees per physical location.
- Have used (or will use) all of the proceeds from the original PPP loan.
- Document at least a 25% reduction in gross receipts in the first, second, or third quarter of 2020 relative the same quarter in 2019.
PPP second draw borrowers can receive a loan amount of up to 2.5 times their average monthly payroll costs during the year one year prior to the loan, or the calendar year. Businesses under NAICS Code 72 can receive loans up to 3.5 times their average monthly payroll costs. However, in no event can PPP second draw loans exceed $2 million. Eligible entities may only receive one PPP second draw loan.
Expansion of Covered Expenditures Eligible for Loan Forgiveness
Just like the first round of PPP loans, borrowers of a PPP second draw loan are eligible for loan forgiveness equal to the sum of their payroll costs, in addition to covered mortgage, rent, and utility payments. However, the Act adds additional categories to the list of covered expenses which qualify for loan forgiveness, such as:
- Covered operations expenditures. Payments for any software, cloud computing, or other human resources and accounting needs.
- Covered property damage costs. Costs related to damage caused by public disturbances that occurred in 2020 and not covered by insurance.
- Covered supplier costs. Expenditures to a supplier pursuant to a contract or purchase order for goods that was in effect prior to taking out the loan that were essential to the recipient’s operations at the time at which the expenditure was made. Costs of perishable goods can be made before or during the life of the loan.
- Covered worker protection expenditures. Personal protective equipment and adaptive investments made to comply with federal, state and local health and safety guidelines related to COVID-19 during the period beginning March 1, 2020, and continuing through the end of the national emergency declaration.
Borrowers are still required to use at least 60% of PPP loan proceeds on eligible payroll costs in order to receive full forgiveness. Loans made under the first round of PPP are also eligible to use the expanded list of forgivable expenses (except for first round loans which have already been forgiven).
The new Act provides that PPP borrowers will be provided the option to choose between an eight-week covered period and a 24-week covered period for purposes of calculating the amount of eligible expenses paid or incurred that would qualify for loan forgiveness.
Lender Safe Harbor
Under the Act, a lender may rely on any certification or documentation submitted by a borrower for an initial or second draw PPP loan. No enforcement action may be taken against the lender, and the lender will not be subject to any penalties relating to loan origination or forgiveness, if: (1) the lender acts in good faith relating to loan origination or forgiveness; and (2) all relevant federal, state, local and other statutory and regulatory requirements are satisfied. This provision of the Act highlights the critical importance of borrowers to not simply rely on bank guidance and instead carefully navigate the rules and regulations of PPP loans with their financial and legal advisers.
Increased Eligibility for Employee Retention Tax Credit
The original CARES Act created a 50% tax credit to employers for wages paid to employees when business operations have been fully or partially suspended, or the company has experienced a significant decline in gross receipts. However, the CARES Act did not allow this "employee retention tax credit" to any company which received a PPP loan (even if the loan was not forgiven). The new Act changes this and now permits PPP borrowers to also receive the employee retention tax credit. However, the credit is still not available on wages paid with the proceeds of a forgiven PPP loan. Because the credit is only available for wages paid with non-PPP loan funds, employers seeking to maximize this tax credit might consider using PPP loan proceeds to pay the minimum amount of wages required for loan forgiveness (60%), and use non-PPP loan funds to pay as much of other eligible expenditures allowed with PPP loan funds.
Effective January 1, 2021, the employee retention tax credit has been increased from 50% to 70%, and the maximum credit per employee has been increased from $5,000 for wages paid in 2020, up to a total of $14,000 for wages paid during the first two quarters of 2021 ($7,000 maximum credit per quarter).
Under the CARES Act, generally only companies with 100 or fewer employees were eligible to claim the employee retention tax credit. The Act increases this eligibility threshold to 500 employees or less. However, companies in the hotel or restaurant industry taking a PPP loan may not automatically qualify, as the special exceptions from the counting and affiliation rules under the PPP do not also apply for purposes of determining eligibility for the employee retention tax credit.
This Insight is intended only to provide an overview of the matters addressed herein and does not constitute legal advice. If you have any questions regarding a specific issue, please seek appropriate legal counsel.