So Much Promise
I am not embarrassed to say that I was excited at the introduction of the bill that would eventually be enacted as the CARES Act.[i] In particular, I viewed the Paycheck Protection Program[ii] as a practical means of getting funds into the hands of those closely held businesses that needed them to survive the present economic downturn.[iii]
Even as the legislation evolved in Congress, over a short but stressful period, the basic features of the PPP remained the same: billions of dollars in nonrecourse, unsecured, SBA-guaranteed loans to be used by small businesses to satisfy their payroll costs, rental and utility expenses, as well as interest on certain pre-existing indebtedness; significantly, the loans would be forgiven if businesses could demonstrate that the proceeds were used for their intended purpose; and, finally, such forgiveness would not be treated as income from the discharge of indebtedness for purposes of determining taxable income.
Now Comes the Hard Part
The passage of any legislation, however, is only the first step toward accomplishing its goals. It has to be implemented, which is no easy task in the best of circumstances, let alone during the unprecedented shutdown of much of the nation’s economy, and it can be especially challenging for a measure as complex as the CARES Act.
Granted, the implementation of a law involves some degree of interpretation by the agencies charged with making it work. At times, Congress will authorize an agency to fill in the blanks, as it were.[iv] This process takes time.[v]
In the case of the PPP, however, the timeline was necessarily accelerated. The legislation was enacted on March 27 – by which time, 21 States were already in lockdown[vi] – and PPP loans became available on April 3.[vii] By April 16, the $349 billion appropriated by Congress for PPP loans was gone.[viii] The following week, Congress passed the Paycheck Protection Program and Health Care Enhancement Act,[ix] which authorized an additional $321 billion for the PPP.[x]
During a relatively short period, the SBA has issued, revised and updated its “interim final rule” a total of nine times, most recently on May 8.[xi] The SBA has also issued a number of FAQs[xii] to assist businesses with understanding the PPP; these have been updated approximately fourteen times.
“Economic Need”: What Was Intended?
Although most of these revisions and updates would not be described as “game changers” (though the clarification they have provided is certainly welcome), some of them have caused a number of business owners to second-guess their decision to apply for a loan under the PPP.
The principal reason for this change of heart? The addition of “Question & Answer 31” to the PPP’s hit parade of FAQs:
Question: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?
Answer: . . . [B]orrowers must assess their economic need for a PPP loan . . . at the time of the loan application. . . . [B]orrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. . .[xiii]
How does one define a “large” company? The FAQ merely states: “[I]t is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith.” No further guidance is provided.
What constitutes an “adequate source of liquidity?” Must the business make a capital call on its owners if they have the wherewithal to invest more in the business? Must it draw down on its available line of credit?[xiv] Must it exhaust its reserves? Must it reassign funds it had already designated for another business-related purpose? Query whether an approach similar to an “accumulated earnings tax” analysis should be applied; basically, has the borrower accumulated earnings beyond the reasonable needs of the business?[xv] Again, no other guidance has been provided.
This uncertainty – coupled with the risk of civil penalties, or criminal liability for “knowingly” making a false statement – has left the owners and officers of many closely held businesses on edge. They are reluctant to certify as to the “economic need” for the PPP loan – or are at least ambivalent about doing so – in the absence of more definitive rules.
Give It Back?
As if sensing this possibility – but probably not appreciating its breadth – the SBA announced a change to its interim final rule pursuant to which any borrower that applied for a PPP loan prior to April 24, 2020, that was concerned about its eligibility in light of FAQ 31, and that repaid the loan in full by May 7, 2020, would be deemed to have made the required certification in good faith.[xvi] Although this option brought peace of mind to many borrowers, the “squid pro row”[xvii] for such relief was significant: withdrawal from the PPP.
Last week, probably after having received what must have been a number of inquiries regarding the foregoing issues, the SBA issued FAQ 43,[xviii] which extended the repayment date from May 7 to May 14, 2020, thus giving businesses more time to consider their options.
In addition, and as if to dangle a carrot, the SBA issued FAQ 45[xix] to clarify that if a business repays its PPP loan by May 14, 2020, it will be treated as though it had never received a PPP loan for purposes of the Employee Retention Credit.[xx] Therefore, the business may qualify for the credit if it is otherwise an eligible employer for purposes of that benefit.[xxi]
For those businesses that were not concerned about their eligibility for a PPP loan, their participation in the program lost some of its luster when the IRS recently announced[xxii] that a business with such a loan will not be allowed an income tax deduction for the payment of any payroll costs, rent, and utilities – as directed by the PPP – that would otherwise be deductible by the business, if the PPP loan used to pay these expenses is forgiven, and such debt forgiveness is excluded from the gross income of the business for tax purposes.[xxiii]
These deductions, which were to be generated by using the PPP loan proceeds for their intended purpose – not to mention the resulting tax savings and liquidity – were taken for granted by most loan applicants and their advisers.
In fact, last week, members of the Senate Finance Committee and of the House Ways and Means Committee asked that the IRS reconsider its position. A couple of days later, a bipartisan group of Senators introduced a measure to clarify that the PPP does not affect the tax treatment of ordinary business expenses paid with PPP loan proceeds, with the result that such expenses would remain deductible for purposes of determining taxable income.[xxiv]
It remains to be seen whether the IRS will relent, or whether Congress will overturn the IRS’s position.
Meanwhile, the inexorable march toward May 14 continues.
While the CARES Act provides that a business will be eligible for forgiveness of its PPP loan in an amount equal to the sum of payroll costs and any payments of rent, utilities, and interest on certain indebtedness, made during the eight-week period beginning with the receipt of the loan proceeds,[xxv] the SBA determined[xxvi] that the non-payroll portion of the forgivable loan amount should be limited to 25 percent, whereas at least 75 percent of the PPP loan should be expended for payroll costs.[xxvii]
Many businesses that have already received their PPP loan proceeds have not yet spent the money, primarily because they are still shuttered by order of their state governments. The owners of these businesses don’t see how they can possibly apply the funds to pay salaries while their businesses remain closed and their employees remain at home. Their preference would be to wait until the stay-at-home orders are lifted so they can hire back the employees they have furloughed,[xxviii] and start generating revenue; if their businesses have to spend the funds on payroll now, the owners claim, they will not have the liquidity necessary to reopen and, hopefully, jumpstart their businesses later.
Meanwhile, the clock for the eight-week “covered period” during which the loan proceeds are required to be spent is ticking away.
Other businesses are wondering whether they should have waited longer before applying for a PPP loan, perhaps closer to the statutorily prescribed June 30, 2020 loan origination deadline, by which time there would be a greater chance of their being back in business and of satisfying the “75 percent payroll cost expenditure test” during the eight-week covered period.
Still others are confident that they will never satisfy this 75 percent test because their labor costs are not as significant as their rental costs or capital costs.[xxix] They nevertheless applied for the PPP loan because they needed the money to stay afloat.
Last week, in a letter dated May 5, 2020, a bipartisan group of Senators asked that the Treasury and the SBA consider increasing the threshold for non-payroll expenses from 25 percent to 50 percent. It is anyone’s guess what will happen.
How are these businesses going to fare when, after eight weeks, they apply to their lender for forgiveness of their PPP loan? Will they be saddled with indebtedness that will have to be repaid in two years, albeit at a low rate of interest?[xxx] Perhaps worse, will they be charged with not having certified in good faith as to their intended use of the loan proceeds?
Again, the May 14 “guilt-free” repayment date is approaching.
The foregoing highlighted some of the thorniest issues facing many businesses that have not yet applied for a PPP loan, as well as those businesses that have already received PPP loans and which may be thinking about whether their applications for forgiveness will be well-received.
With respect to the latter, the SBA has extended the repayment date by a mere seven days.
Although the FAQs’ repayment option was drafted to address the issue of those applicants who, in retrospect,[xxxi] have determined they do not need a PPP loan, it is also available, practically speaking, to any other business that chooses to avoid an inquiry down the road – regarding its eligibility under the PPP, or regarding its certification as to the use of the loan – by repaying the loan and dropping out of the program.
In light of the questions raised by Congress over the deductibility of the payroll costs and other statutorily approved expenses paid with the loan proceeds, and over the appropriateness of applying the 75 percent threshold test to all businesses, the SBA and the Treasury should extend the repayment deadline by a meaningful period so as to allow these matters to be resolved.[xxxii]
“Baby don’t blow it, Don’t put my good advice to shame! Baby you know it, Even dear Abby’d say the same!”[xxxiii]
What is left for a business that decides to stay away from the PPP, its ever-changing rules, and its seemingly more elusive promise of loan forgiveness?
Plenty. By choosing not to take a PPP loan, a business is free, within the limits of the law, to let go of employees and to reduce the salaries of whatever employees it retains. Even as to those whom it furloughs, the business may choose to continue paying their health care premiums, as many have.
Rather than using PPP loans to make rental and interest payments for which no tax deduction may be available, the business may seek to renegotiate and or defer its obligations, the payments of which will still be deductible for tax purposes.[xxxiv]
Deferring Employment Taxes
Such a business may also qualify for certain tax benefits from which its participation in the PPP would have precluded it.
For example, the CARES Act allows employers to defer the deposit and payment of the employer’s share of social security taxes.[xxxv]
The deferral applies to deposits and payments that would otherwise be required to be made during the period beginning on March 27, 2020, and ending December 31, 2020. The deferred amounts must be deposited by the following dates (the “applicable dates”): (1) On December 31, 2021, 50 percent of the deferred amount; and (2) On December 31, 2022, the remaining amount.
A business that has received a PPP loan, that has not yet been forgiven, may defer the deposit and payment of the employer’s share of social security tax. However, once an employer receives a decision from its lender that its PPP loan is forgiven, the employer is no longer eligible to defer the deposit and payment of the employer’s share of social security tax that is due after that date.
In order to provide a timeframe within which to consider the benefit of this deferral, a PPP borrower applies to its lender for forgiveness of the loan after the eight-week covered period that began with the borrower’s receipt of the loan proceeds. The lender must issue its decision no more than sixty days after its receipt of the application.[xxxvi]
However, the amount of the deposit and payment of the employer’s share of social security tax that was already deferred through the date that the PPP loan is forgiven continues to be deferred and will be due on the applicable dates.[xxxvii]
A qualifying business may want to take advantage of and maximize this deferral opportunity and the increased liquidity that should arise from it.[xxxviii]
Employee Retention Credit[xxxix]
The CARES Act also provides businesses an Employee Retention Credit which may be claimed by eligible employers for wages paid after March 12, 2020, and before Jan. 1, 2021.[xl]
The credit is available to all businesses that have experienced an “economic hardship” due to COVID-19 – except for businesses that receive PPP loans.[xli] For purposes of this credit, a business experiencing an economic hardship includes one that has suspended its operations due to a government order related to COVID-19, or one that has experienced a “significant decline” in gross receipts.[xlii]
A business may have to fully or partially suspend its operations because a government order limits commerce, travel, or group meetings due to COVID-19 in a manner that prevents the business from operating at normal capacity.[xliii]
A significant decline in gross receipts begins in the first calendar quarter in 2020 in which a business’s gross receipts are less than fifty percent of its gross receipts for the same quarter in 2019.[xliv] The decline ends the first calendar quarter in 2020 after the quarter in which the business’s gross receipts are greater than eighty percent of its gross receipts for the same quarter in 2019. The business calculates these measures each calendar quarter.
The amount of the tax credit is fifty percent of up to $10,000 in “qualified wages” paid to an employee by an employer-business for all calendar quarters.[xlv] Thus, the employer’s maximum credit for qualified wages paid to any employee for all calendar quarters is $5,000. Qualified wages include the cost of employer-provided health care.
The wages that qualify for the credit vary based on the average number of the employer’s full-time employees in 2019. If the employer had 100 or fewer employees on average in 2019, the credit is based on the wages paid to all employees, regardless if they worked or not. If the employer had more than 100 employees on average in 2019, then the credit is allowed only for wages paid to employees for time they did not work.[xlvi] In each case, the wages that qualify for purposes of determining the credit are wages paid for a calendar quarter in which the employer experiences an economic hardship.[xlvii]
Beginning with the second calendar quarter of 2020, to claim the credit, employers should report their total qualified wages and the related health insurance costs for each quarter on their quarterly employment tax returns.[xlviii] The credit reduces, on a dollar-for-dollar basis, the employer’s share of social security taxes on the qualified amounts paid.[xlix]
The credit is refundable because if, for any calendar quarter, the amount of the credit to which the employer is entitled exceeds the employer’s share of the social security tax on all wages paid to all employees, then the excess is treated as an overpayment and is refunded to the employer. Consistent with its treatment as an overpayment, the excess will be applied to offset any remaining tax liability on the employment tax return and the amount of any remaining excess will be reflected as an overpayment on the return.[l]
Neither the portion of the credit that reduces the employer’s applicable employment taxes, nor the refundable portion of the credit, is included in the employer’s gross income. At the same time, though, the employer’s aggregate deductions would be reduced by the amount of the credit.[li]
Latest Developments re the Credit
It should be noted that, last week, a bipartisan group of lawmakers proposed increasing the amount of the tax credit from $5,000 per employee for the remainder of the year to $12,000 per employee per quarter, thereby making the credit a more valuable and more meaningful economic incentive for employers. The bill would also remove some of the limits, based on the number of employees a business must have, in order to make it easier to qualify for the credit. Stay tuned.
In addition, until last week, the IRS had taken the position that an employer could not qualify for the credit by paying the health plan premiums for employees that have been furloughed and are not being paid a salary by the employer-business. However, in response to a letter from the chairs of the Senate Finance Committee and the House Ways and Means Committee, the Treasury revised the FAQs to change its position.[lii]
So much to consider. So little time in which to do it.
There is no sugarcoating the circumstances in which so many businesses find themselves. The new rules that were enacted to help businesses through this period are complex, yet decisions have to be made, and sooner rather than later.
The best a closely held business can do is to review the guidance that’s out there with its advisers, consider the condition of the business, run the numbers, and make the choice with which the business and its owners are most comfortable, but remaining alert for possible changes coming out of Washington.
It isn’t ideal, but . . .
[i] The Coronavirus Aid, Relief and Economic Security Act. P.L. 116-136.
[ii] The “PPP” is found in Sections 1101 through 1107 of the CARES Act.
[iv] We (meaning tax people, at least in my world) talk about procedural vs. interpretive vs. legislative rules and regulations.
[v] For example, regulations are proposed, comments are solicited, and hearings are held before the regulations are revised (maybe) and finalized. Alternatively, regulations may initially be issued in temporary form when immediate guidance is needed. The temporary regulation is still treated as a proposed regulation and, so, follows the path outlined above before being finalized.
[vi] That number increased to 30 States by March 30, and 42 States by April 6 (three days after the PPP was launched).
[vii] Though many private lenders – including a few of the “too big to fail” variety (remember them?) – were late in participating and, when they did, several favored customers over others, notwithstanding the first-come, first-serve directive from the government. Oh well. Penalties anyone?
[viii] It should be noted that Section 1114 of the CARES Act directed the SBA to issue regulations to carry out the PPP within 15 days after the date of enactment.
[ix] “CARES Act 3.5.” P.L. 116-139.
[x] It was reported last week that over $100 billion remains available.
[xii] Frequently asked questions.
[xiii] As is often the case, a few bad actors take advantage of a situation, the government overreacts, and many of the intended beneficiaries of legislation are either frozen out, or voluntarily “remove” themselves for fear of the consequences of perhaps being found ineligible.
[xiv] Mind you, the CARES Act suspended the ordinary requirement that SBA borrowers demonstrate they are unable to obtain credit elsewhere. Section 1102(a)(2)(I) of the CARES Act.
[xv] See IRC Sec. 531 et seq. This has been my approach.
[xvi] 85 FR 23450 (April 28, 2020). The SBA, “in consultation with the Secretary [of the Treasury], determined that this safe harbor is necessary and appropriate to ensure that borrowers promptly repay PPP loan funds that the borrower obtained based on a misunderstanding or misapplication of the required certification standard.” Misunderstanding? Misapplication? How about poor drafting and fear of the consequences if one’s interpretation is rejected? The PPP application states that knowingly making a false statement is punishable by a fine and/or imprisonment; this includes the certification as to “need.”
[xvii] From Austin Powers in Goldmember. Translated, “quid pro quo.” Cut me some slack, OK. Starting my ninth week of house arrest – with my mother-in-law. (She’s OK, really.)
[xviii] May 5, 2020.
[xix] May 6, 2020.
[xx] Also passed as part of the CARES Act. Section 2301.
[xxi] More on this later.
[xxii] Notice 2020-32 (April 30, 2020).
[xxv] Congress probably thought we’d be back to “normal,” or at least approaching something like it, after eight weeks. Turns out that was wishful thinking.
[xxvi] In an early version of its interim final rule. 85 FR 20811 (April 15, 2020). It should be noted that although this version of the interim final rule was issued on April 2, 2020, and although loan applicants were told they could they rely on such rule, the rule did not become effective until April 15, 2020.
I can tell you that many active real estate businesses (and their advisers) waited for the SBA to modify this version of the interim rule by dropping its per se treatment of real estate development and rental businesses as passive and, thus, not eligible for SBA loans, including under the PPP. See 13 CFR 120.110 and described further in SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2. Inexplicably, that has not happened, though the industry continues to press Congress and the SBA.
[xxvii] To “effectuate the core purpose of the statute and ensure finite program resources are devoted primarily to payroll.”
[xxviii] Meanwhile, these former employees are receiving state unemployment benefits plus an additional federal benefit of $600 per week; in some cases, they are making more than if they had remained employed.
[xxix] Think of restaurants in large cities. Think of manufacturers.
[xxx] One percent. See the interim final rule. 85 FR 20811.
[xxxi] And with the fear of being lumped together with The Lakers, Ruth’s Chris, and Shake Shack.
[xxxii] After all, it is not the borrower’s fault that they may have applied for the PPP loan based on a “misunderstanding” of the rules.
[xxxiii] With apologies to Frankie Avalon who sang the song “Beauty School Dropout” in the 1978 movie Grease.
[xxxv] Section 2302 of the CARES Act. This tax is imposed on employers at a rate of 6.2 percent of each employee’s wages that do not exceed $137,700 for the 2020 calendar year.
[xxxvi] Section 1106(g) of the CARES Act.
[xxxviii] The IRS has indicated that the Form 941, Employer’s Quarterly Federal Tax Return, will be revised for the second calendar quarter of 2020 (April – June, 2020), and information will be provided to instruct employers how to reflect the deferred deposits and payments otherwise due on or after March 27, 2020 for the first quarter of 2020 (January – March 2020). In no case will employers be required to make a special election to be able to defer deposits and payments of these employment taxes.
[xxxix] The IRS has issued over 90 Frequently Asked Questions regarding this credit. There is no substitute for reviewing these, including the examples, if a business wants to take full advantage of the credit. https://www.irs.gov/newsroom/faqs-employee-retention-credit-under-the-cares-act
[xl] Section 2301 of the CARES Act. The credit is not available for wages paid after December 31, 2020.
[xli] Recall that a business which repays the PPP loan by May 14, 2020 will be treated as having never participated in the PPP for purposes of determining its eligibility for the credit.
[xlii] FAQ 2. The number of employees an employer has does not affect whether it is an eligible employer that may claim the credit. FAQ 16.
[xliii] FAQ 3.
[xliv] FAQs 4 and 39.
[xlv] FAQs 5 and 47.
[xlvi] An aggregation rule applies which treats all entities under common ownership as one employer, including for purposes of determining who is an eligible employer and for the 100 full-time employee threshold.
[xlvii] See FAQs 51 and 52.
[xlviii] Usually, IRS Form 941, Employer’s Quarterly Federal Tax Return.
[xlix] The employer can receive the benefit of the credit even before filing these returns by reducing their federal employment tax deposits by the amount of the credit. The employer will account for the reduction in deposits due to the Employee Retention Credit on the Form 941.
The IRS has posted Frequently Asked Questions about the ability of a business both to reduce deposits for the credit and to defer the deposit of all of the employer’s share of social security tax due before Jan. 1, 2021, as described earlier.
[l] The employer may request an advance payment of the credit from the IRS. This is done by submitting Form 7200, Advance Payment of Employer Credits Due to COVID-19.
[li] Section 2301(e) of the CARES Act; FAQs 85 and 86.
[lii] May 7, 2020 letter from the Treasury to the Chair of the Senate Finance Committee. See FAQ 64, especially Ex. 2.