New Guidelines Exempting PPP Loans from Taxable Income

As part of an end-of-year pandemic relief package, Congress has passed several changes to the Paycheck Protection Program (PPP) and created a “Second Draw” PPP for small businesses that have exhausted their initial loan. Other changes impact eligibility for initial PPP loans, the loan forgiveness process, and the tax treatment of PPP loans.

Congress has also made changes to other programs, including Economic Injury Disaster Loans (EIDL Program), the Employee Retention Tax Credit, a Venue Grant Program, and SBA loan programs, to benefit small businesses. Here’s everything that small business owners need to know now.

How Do New Changes Impact My Existing PPP Loan?

The changes, brought about by the new laws that Congress has implemented for the Paycheck Protection Program (PPP), are designed to help businesses. To give you a better understanding of how these changes will impact your existing PPP loans, we have given a brief overview. Here is everything that you need to know about them.

·        Tax Treatment

The new law overturns the IRS ruling and states that regular business expenses paid for with PPP loan proceeds shall be deductible for tax purposes (applies to past and future loans).

·        Expanded List of Expenses Qualifying for Forgiveness

The list of expenses that PPP funds can be used for (that qualify for loan forgiveness) has been expanded to include the following:

Operations Expense

Defined as payments for business software, cloud computing services, human resources, and accounting needs that facilitate business operations.

Supplier Costs

Defined as payments to a supplier for goods that are essential to the operations of the borrower pursuant to a contract or purchase order in effect before the PPP loan is disbursed or with respect to perishable goods, in effect at any time.

Worker Protection Expenses

Defined as operating or capital expenditures to comply with public health guidance related to COVID-19, including things like drive-through windows, sneeze guards, and personal protective equipment (PPE).

Covered Property Damage Costs

Defined as costs related to property damage or looting due to public disturbances in 2020 that are not covered by insurance or other compensation.

·        Loan Forgiveness Reduction

If you also received an EIDL grant, your PPP loan forgiveness will no longer be reduced by the grant amount.

·        Loan Forgiveness Period

The period for which expenses count toward loan forgiveness will begin on the date of loan origination and end on a date of your choosing. Date must be between 8 and 24 weeks after origination.

·        Simplified Application

If your loan was for less than $150,000, there will be a simplified one-page application process for loan forgiveness.

I Exhausted My Initial PPP Loan, How Does This Help Me?

The brand new “Second Draw” program is for small businesses, non-profits, sole proprietors, and independent contractors who have exhausted their initial PPP loan. The program will be available through March 31, 2021, or until the new funding is exhausted.

·        Eligibility

You are eligible for a second draw loan if you have exhausted your first PPP loan and:

  1. Have less than 300 employees
  2. Have experienced a greater than 25% reduction in gross receipts during the first, second, third, or fourth quarter in 2020 relative to the same quarter in 2019.

Entities with significant ties to China are ineligible for a second draw loan.

·        Loan Amount

The maximum loan amount is the average monthly payroll costs for the entity during the 12 months prior to the loan, or at the election of the borrower, 2019 multiplied by 2.5 (or 3.5 for employers in the accommodation and food service industry).

Seasonal employers utilize average monthly payroll costs for a 12-week period between February 15, 2019, and February 15, 2020. A loan may not exceed $2 million.

·        Loan Forgiveness

The amount of loan that can be forgiven is the lesser of:

  1. Costs incurred or expenditures made between the date of the origination of the loan and ending on a date of your choosing that is between 8 and 24 weeks after origination for (a) payroll costs, (b) qualifying mortgage interest or rent obligations, (c) covered utility costs, (d) covered operations costs, (e) covered property damage, (f) covered supplier costs, and (g) covered worker protection expenditures; or
  2. Payroll costs for the same period divided by 0.60 (this serves as a cap on the total loan forgiveness to ensure that at least 60% of the total amount forgiven is for payroll costs).

Like original PPP loans, the amount of loan forgiveness can be reduced if the borrower has (1) reduced the number of employees or (2) employee salaries by more than 25%. However, the same safe harbors that apply to original PPP loans also apply to Second Draw loans.

Set-Asides: $35 billion is set aside for first-time borrowers, $25 billion is set aside for employers with 10 or fewer employees, or for loans less than $250,000 for entities located in a low-income neighborhood.

What If I Never Received a PPP Loan?

For new PPP applicants, the loan process will largely remain the same with a few major changes:

  • The PPP program is open through March 31, 2021, or until the new funding is exhausted.
  • If you are a 501(c)(6), a local news media organization, or a housing cooperative, you may be newly eligible for a loan.
  • You may qualify even if you took advantage of the Employee Retention Tax Credit.
  • If you are a publicly-traded company, you are now prohibited from receiving a loan.
  • The maximum loan amount is now $2 million (previously $10 million).
  • Group insurance payments can be included in your payroll costs when determining your maximum loan amount.
  • If you are a seasonal employer, you have greater flexibility in picking the 12-week period between February 15, 2019, and February 15, 2020, used to determine your payroll costs, and thus your maximum loan amount.

New borrowers have until the end of the covered period of their loan (up to 24 weeks after origination) to restore a reduction in their number of employees or reduced wages in order to avoid having their loan forgiveness reduced.

Note: The safe harbors for when an employer can’t find qualified employees or where complying with COVID-19 related safety measures prevents a return to February 2020 levels of business activity and staffing remain in effect.

Which Other Programs That May Help My Small Business Have Been Changed or Updated?

There have been several new programs implemented to help small businesses. These programs have been specifically introduced to make a difference for small businesses and help them overcome any hardships that they have been experiencing. The programs that may help your small business include the following ones:

·        Expanded Employee Retention Tax Credit

The new law significantly expands the employee retention tax credit beginning on January 1, 2021. The credit expires on June 30, 2021. The prior credit was 50% on $10,000 in qualified wages for the whole year (or a maximum of $5,000 per employee). The new credit is 70% on $10,000 in wages per quarter (or a maximum of $14,000 per employee through June 30).

The new law also expands which employers are eligible. Prior to the new law, the employee retention tax credit applied only to an employer who experienced a decline in gross receipts of more than 50% in a quarter compared to the same quarter in 2019. Eligibility is now expanded to include employers who experienced a decline of more than 20%.

In addition, the employee cap that makes it easier to claim the tax credit has been raised to 500 employees from 100 employees. Now, employers with 500 or fewer employees can claim the credit for wages paid to employees irrespective of whether the employee is providing services.

Employers can now also receive both the Employee Retention Tax Credit and a PPP loan, just not to cover the same payroll expenses.

·        EIDL Grants

The new law reopens the $10,000 EIDL Grant program. Priority for the full amount of the EIDL grant will be given to small businesses with less than 300 employees, located in low-income neighborhoods, who have experienced a 30% reduction in gross receipts during any 8-week period between March 2, and December 31, 2020, compared to a comparable 8-week period before March 2. If you meet this description and received a grant that is less than $10,000, you can reapply to receive the difference.

·        Grants for Shuttered Venue Operators

The law creates a new $15 billion grant program for eligible live venue operators or promoters, theatrical producers, live performing arts organization operators, museum operators, motion picture theatre operators, or talent representatives that have experienced at least a 25% drop in revenue.

Grants are equal to the lesser of $10 million or 45% of gross revenue earned in 2019. Grants must be used for specified expenses such as payroll costs, rent, utilities, and personal protective equipment. If you receive a grant, you may not apply for a new PPP loan.

·        SBA Loan Debt Forgiveness

The new law resumes the government payment of monthly principal and interest on small business loans guaranteed by the SBA under the 7(a), 504, and Microloan programs. Borrowers with loans approved by the SBA prior to the CARES Act will receive an additional three months of payments beginning in February of 2021. Those payments will be capped at $9,000 per borrower per month.

After that, the certain borrower will receive an additional five months of payments, including borrowers with SBA microloans or 7(a) Community Advantage loans or borrowers with 7(a) or 504 loan in hard-hit sectors such as educational services, arts, entertainment and recreation, food service and accommodation, support activities for mining, and oil and gas extraction, apparel manufacturing, clothing and clothing accessories stores, sporting goods, hobby, book, and music stores, air transportation, transit and ground passenger transportation, scenic and sightseeing transportation, publishing industries, motion picture, and sound recording, broadcasting, rental and leasing services, and personal and laundry services.

New SBA loans made or approved between December 22, 2020, and September 30, 2021, will receive six months of government payment of principal and interest, also capped at $9,000 per month.

Important Tax Changes That Have Been Implemented

An important change outlined in the new regulation is that forgiven PPP loans will be completely tax-free. Plus, any usually tax-deductible business expenses paid for with PPP loans will also continue to be deductible. The Consolidated Appropriations Act, 2021 (CAA 2021), H.R. 133, Division N, Section 276, provides that deductions are allowed for otherwise deductible expenses paid with the proceeds of a PPP loan that is forgiven. Also, the tax basis and other attributes of the borrower’s assets will not be reduced as a result of the loan forgiveness.

Specifically, the updated language says, “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income provided” by Section 1106 of the CARES Act (which has been re-designated as Section 7A of the Small Business Act). This provision applies to loans under both the original PPP and subsequent PPP loans.

One other major change in the bill concerns how PPP loans interact with the Employee Retention Tax Credit (ERTC). Originally, businesses that took out PPP loans were prohibited from using the ERTC to reduce their tax burden and vice versa. This has been changed so businesses can take advantage of both PPP and the ERTC in 2020 and 2021.

Conclusion

The new guidelines introduced by Congress to help small businesses who have taken PPP loans are designed to make a big difference. The best part is that it will help businesses struggling with their taxes since it will ensure that PPP loans are exempt from taxable income.