Just over three weeks to go, then 2020 will be behind you. But don’t drop your guard just yet. Three weeks is a long time – plenty of time, in fact, for one more punch to the gut, another kick in the teeth, etc.
Your business started off the year well enough, as did many others. You were enjoying the benefits of the longest expansion of the U.S. economy on record. In that environment, and barring some unforeseeable disaster,[i] it seemed that your plans for transitioning the business and for retirement would be attainable.
Yes, there was some talk of a flu-like virus in China, and Mr. Trump was scheduled to be tried in the Senate, following the House’s having approved articles of impeachment on charges of abuse of power and obstruction of Congress;[ii] however, it was otherwise relatively quiet on the home front.[iii]
By February[iv], the CDC confirmed that the virus – which the WHO had named COVID-19 – had spread across many parts of the country. NIAID Director Dr. Fauci, and CDC Director Redfield, announced that the U.S. would “soon need to move toward aggressive social distancing, even at the risk of severe disruption to the nation’s economy and the daily lives of millions of Americans.”[v]
In mid-March, the WHO declared a pandemic; the very next day, the stock market crashed – as did much of your retirement savings; one day later, Mr. Trump declared a national emergency;[vi] the White House reluctantly issued social-distancing guidelines; governors across the country, including New York,[vii] issued stay-at-home orders in order to contain, and prevent the spread of, the virus;[viii] the Federal Reserve cut interest rates to near-zero percent.
Economic activity, both domestically and around the world, plummeted. With thousands of businesses shuttered indefinitely, millions of Americans lost their jobs, practically overnight; the federal and state governments were inundated with jobless claims.
You furloughed many of your employees, and reduced the salaries of others while also telling them to work from home as best they could. You contacted your landlord and your bankers to discuss contingency arrangements, including your line of credit. You reached out to customers and suppliers, and even a friendly competitor or two, practically all of whom were in equally challenging circumstances. You examined other business expenditures, made cuts where warranted and possible – including to your own salary and distributions – exhausted the modest reserve the business had set aside for “rainy days,” and dipped into your personal savings to cover certain expenses.[ix]
The outlook was pretty grim heading into April, and the prognosis for the rest of the spring and summer months was not much better.
On March 25, the Senate passed the CARES Act, and Mr. Trump signed it into law on March 27.[x]
Within a couple of days of its passage, your accountant informed you that the new legislation included something called the Paycheck Protection Program, or PPP. In fact, by April 3, banks participating in the PPP were accepting loan applications.
The CARES Act established the PPP to provide loans to “small” businesses through the Small Business Administration’s “7(a)” loan program. The PPP’s stated goal was to get badly needed funds into the hands of small businesses so as to enable them, and their employees, to survive the economic downturn that resulted from the stay-at-home orders issued in response to the pandemic.
In order to expedite the infusion of these funds into the economy, the program utilized streamlined eligibility criteria, though a loan applicant was required to make a “good faith certification” that, given the economic hardship arising from the economic shutdown, the funds were necessary to support the applicant’s ongoing business operations, and would be used to retain workers, maintain payroll, and pay for utilities, rent and similar expenses.[xi]
Moreover, the program provided that a loan recipient could subsequently apply for forgiveness of the loan, without adverse tax consequences[xii] – meaning the canceled debt will be excluded from the borrowers’ gross income for income tax purposes – provided the borrower can demonstrate that the PPP loan proceeds were applied toward statutorily-prescribed purposes; in particular, payroll costs.[xiii]
After discussions with your accountant and with the relationship manager at your bank, your business applied for and received a PPP loan. The loan proceeds enabled you to hire back all of the individuals whom you had furloughed, to restore employee salaries that had been reduced (even for those who could not work because of the stay-at-home orders), and helped to satisfy other obligations of the business.
Yes, the SBA’s multiple changes to the so-called “interim final rules” drove you batty but, at the end of the day, there was no denying that the PPP made a positive difference for you and for your employees. From what you heard, other businesses had the same experience.
Time for Gifting?
You exhausted your PPP proceeds by the beginning of July. By that point, your business had started to recover – a pleasant surprise considering the outlook at the beginning of April – though its activity level and revenues were still depressed compared to 2019. Notwithstanding this relatively positive development, there were many other reasons to remain cautious and concerned.
For one thing, many other businesses and individuals were still struggling, and there were parts of the country in which the virus continued to wreak havoc.
Then, there was the nation’s “leadership.” After their enactment of the CARES Act, the folks in D.C. did little to inspire confidence in their ability to revive the economy and ensure the safety of individuals. Instead, they reinforced the impression held by many that their own political job security was foremost in their minds.
Against this backdrop, your estate planner suggested that you may want to consider making gifts of equity interests in your business to trusts for the benefit of your family. The uncertainty created by all of the forgoing factors, the planner informed you, along with the fact that your business had not yet fully recovered from the effects of the economic shutdown, could support a relatively low valuation for purposes of determining the gift tax consequences of the transfer.
Because the long-term prospects for the business were good – though perhaps not as strong as they were at the beginning of the year – and because your estate was on the verge of exceeding the exemption amount determined for 2020,[xiv] a gift of equity in the business, at a relatively low value, offered an excellent opportunity to shift much of the future appreciation in the value of the business to your kids.
Although the estate planner made a pretty compelling argument, you decided against making such a gift for the same reasons given by the planner in support of your making the gift: the immediate economic uncertainty, and the continuing threat of the virus. You weren’t comfortable with giving up any part of the asset from which you derived the bulk of your income – at least not yet.
At some point after the general election on November 3, 2020, Mr. Biden was declared president-elect.[xv] The Democrats retained control of the House (albeit with a reduced majority), while the fate of the Senate remains undecided, with the Republicans holding 50 seats and the Democrats 48 seats, at least until the votes are tallied following the January 5, 2021 runoff elections for both of Georgia’s Senate seats.[xvi]
By all accounts, the two races in Georgia are very tight. If the Democrats take both seats, then they and the Republicans will each hold 50 seats in the Senate, with any deadlock being broken by the Vice President.[xvii]
Your estate planner contacted you again, just before Thanksgiving. Trump’s efforts to overturn the election results have all failed, he told you.[xviii] If the Democrats take control of the Senate and, thereby, of Congress, they may pass legislation affecting the federal estate and gift taxes, possibly with retroactive effect to January 1, 2021. He reminded you that Mr. Biden’s tax plan, as described during the campaign, called for a significant reduction of the federal unified gift and estate tax exemption amount – to one-half of the current exemption of $11.58 million, and perhaps even lower, to the 2009 level of $3.5 million for the estate tax and $1.0 million for the gift tax.[xix]
He advised you that, under the circumstances, the most conservative plan would be for you to make gifts of equity interests in your business before the end of 2020; these gifts, he suggested, should be made in trust for the benefit of your family, to which you should allocate your GST exemption.[xx] As he put it, “You’re in a ‘use it or lose it’ situation.”
This time around, your estate planner’s advice strikes a chord. By making such gifts now, you will have removed an asset – in fact, a portion of your most valuable asset and the one that is most likely to increase in value – from the reach of the federal estate tax.[xxi] If you fail to make such gifts before the end of 2020, and if a Democrat-controlled Congress acts to reduce the estate and gift tax exemption retroactively,[xxii] as of January 1, 2021, you will have lost a rare opportunity to transfer value to your family free from federal gift and estate taxes.
Last week, you contacted your accountant to review the information provided by the estate planner, and to discuss the impact that a gift would have upon your own cash flow and lifestyle. “Not so fast,” she said. “You may have to notify your PPP lender, or even the SBA.”
A couple of months ago, the SBA issued a Notice regarding certain procedures that had to be followed in connection with a change in ownership of a business entity with an outstanding PPP loan (the “Notice”).[xxiii]
Change of Ownership
According to the Notice, a “change in ownership” occurs with respect to a closely held PPP borrower when at least 20% of the “common stock or other ownership interest” of the borrower is sold or “otherwise transferred,” whether (i) in one or more transactions, (ii) by one or more transferors, (iii) to a new or to an existing owner of the entity (as in the case of a cross-purchase).[xxiv] For purposes of determining whether there has been such a change, all sales and other transfers of ownership interests occurring since the date of the approval of the PPP loan have to be aggregated, whether or not they are connected to each other.
The Notice provides that a PPP borrower must notify their PPP lender, in writing, before “closing” any change of ownership transaction. The borrower must also provide the lender with a copy of the proposed agreements or other documents by which the proposed transaction would be effectuated.
The Notice then describes the circumstances in which the approval of only the PPP lender is required prior to the sale or transfer, and those in which the SBA’s approval is also required.[xxv]
PPP Lender Approval
Specifically, a PPP lender may approve a change of ownership without the SBA’s prior approval if (a) there is to be a sale or other transfer of at least 20%, but not more than 50%, of the common stock or other ownership interest of the PPP borrower,[xxvi] or (b)(i) the borrower completes, and submits to the PPP lender, a forgiveness application (along with supporting documentation) that reflects its use of the PPP loan proceeds, and (ii) an interest-bearing escrow account, controlled by the PPP lender, is established with funds equal to the outstanding balance of the PPP loan.[xxvii]
The PPP lender is required to notify the SBA within 5 days of completion of the change in ownership transaction. Among the items to be provided to the SBA are: (i) the names of the new owners of the business entity, (ii) their ownership percentages, (iii) the TINs for any owners that hold at least a 20% equity interest in the business and, (iv) if relevant, the location, and the amount of funds in, the escrow account controlled by the PPP lender.
Where the proposed change of ownership of the PPP borrower does not satisfy the conditions set forth above – because the transfer exceeds 50% of the ownership interest of the borrower, and a forgiveness application has not been submitted, or it has been submitted but no escrow has been established – the borrower must obtain the SBA’s prior approval of the change of ownership; the PPP lender cannot unilaterally approve the change of ownership.
In order to obtain the SBA’s approval, the PPP borrower must submit a request to the SBA which includes, among other things, the following: (i) the reason the borrower entity cannot fully satisfy the loan or establish the escrow, (ii) the details of the proposed transaction that will effectuate the transfer of ownership, (iii) a copy of the PPP note, and (iv) any letter of intent and the purchase and sale agreement.
The SBA has 60 days from receipt of such a request by a PPP borrower to provide its determination.
What Does it Mean?
You may be thinking, “Why would the SBA restrict gifts of interests in a PPP borrower entity among family members?”
For one thing, the Notice does not actually refer to gift transfers of equity in a PPP borrower; nor does it refer to distributions of such equity from an estate or trust to a beneficiary; rather, it speaks of sales of ownership interests, sales of assets, and mergers.
Although the Notice also refers to “other transfers” of ownership interests, this could have been intended to cover exchanges (as distinguished from sales) of ownership interests,[xxviii] or the issuance of new equity by a borrower, whether in exchange for a contribution of property or in recognition of the recipient’s services (i.e., compensation).
Interestingly, the Notice does not refer to transfers that occur upon the death of an owner of a PPP borrower. Granted, the SBA could not have required an owner to obtain the SBA’s approval to die – generally speaking, death is an involuntary act; however, the Notice could have required notice of the death so as to inform the SBA of the change in ownership of the business – it didn’t.
Can it be that the nature of the transfer[xxix] is not relevant; rather, it is the degree of ownership change – the sale or other transfer of at least 20% of the ownership interest of the PPP borrower – that may present a potential issue for the PPP lender or the SBA? For example, may such a change affect the borrower entity’s commitment or ability to satisfy the terms of its unsecured PPP loan, for which the SBA ultimately bears the risk of loss (by virtue of its loan guarantee) in the event the loan is not forgiven?
Although the above reading (that the nature of the transfer is not relevant, and a gift may be covered by the Notice) seems reasonable, the Notice seems to be focused upon commercial-like transactions; as indicated earlier, the Notice refers to the sale of the borrower’s assets, the merger of the borrower with another entity, the letter of intent, the purchase and sale agreement.
What to Do?
Today is December 7.[xxx] The end of the year, and perhaps the end of the enhanced federal gift tax exemption, is only 24 calendar days away.
Like you, many business owners have been ambivalent about giving away part of their business while the economy is still on an unsure footing and the pandemic rages on. Moreover, until the presidential election was settled, most owners were not planning to make substantial gifts of equity in their business before the year-end.[xxxi]
However, it is likely that many business owners, including among them many whose businesses received PPP loans, have finally determined – given the state of the runoffs in Georgia – that the long-term savings from removing property from their estate will outweigh any economic “hardship” they may suffer over the near-term by virtue of having gifted such property. These owners will be making gifts of equity in their business to family members or to trusts for their benefit so as to take advantage of the current gift tax exemption (including any unused exemption carried over to them from a predeceasing spouse, courtesy of the portability rule) before it is greatly reduced.
What is the likelihood that these folks will approach their PPP lender, let alone the SBA (with its 60-day review period), to seek approval of their gift transfers with approximately only three weeks to go?
Which brings us to the next question: assuming gift transfers are subject to the provisions of the Notice, what are the consequences of not complying with the notice and approval requirements prior to making a gift that results in a change of ownership?
Although the Notice does not prohibit gift transfers per se, it is silent with respect to the consequences of non-compliance.
It is reasonable to assume, however, that a borrower’s failure to abide by the notice and approval requirements could be treated as a default which may cause the PPP loan to come due immediately, or which may eliminate the possibility of the loan’s being forgiven.
Thus, in analyzing the proverbial economic pros and cons of making a year-end gift, the owner of a PPP borrower will also have to consider the impact of having to repay the PPP loan.
[i] Remember when you thought the election of a Democratic Socialist would be the scariest scenario for your business? Bernie Sanders was still the frontrunner for the Democratic Party’s nomination at that time, and Mr. Biden was in the number two spot.
[ii] He was acquitted on February 5, 2020.
[iii] Aside from the politicians vying to be selected as the Democratic Party’s standard-bearer in the national elections (which were then still many months away, or so it seemed), and the all-too-common shootings.
[ix] At that point, you may have regretted not having moved to a state in which cannabis products were legal.
Speaking of which, the House voted last Friday to decriminalize marijuana at the Federal level. All eyes turn to Georgia – see below.
[x] Coronavirus Aid, Relief and Economic Security (“CARES”) Act; P.L. 116-136.
This legislation actually began in the House, as required under the Constitution. The Senate “amendment” to the House bill basically replaced the House version in its entirety; the House then accepted the Senate version by voice vote, before sending it to the President for execution.
[xi] The SBA guaranteed 100% of the loans made under the PPP, and the loans were nonrecourse as to any individual owner of an eligible recipient-business.
[xii] The IRS continues to insist, contrary to Congressional intent, that expenses which were paid with PPP loan proceeds should not be deductible by the borrower for purposes of determining the borrower’s tax liability. See https://www.taxlawforchb.com/2020/11/the-irs-forgiven-ppp-loans-and-business-deductions-once-was-a-mistake-twice-is-an-inexcusable-decision/ .
[xiii] Any loan that remains outstanding following a borrower’s application for forgiveness will have a maximum maturity of 10 years and bear a maximum interest rate of 4 percent. The SBA will continue to guarantee the remaining balance.
[xiv] $11.58 million per individual. IRC Sec. 2010. It is scheduled to increase to $11.7 million in 2021.
[xv] Reminder: The 12th Amendment to the Constitution governs the election of the president. The electors of the Electoral College will not meet in their respective states until December 14, 2020, the results are delivered to the Senate on December 23, 2020, and the electoral votes from each state are certified by Congress on January 6, 2021.
By what right does the anything-but-impartial media “declare” a winner?
[xvi] Mind you, the rest of Congress – the 117th – will begin “working” on January 3, 2021.
[xvii] The V.P.-elect being Ms. Harris.
[xviii] Meanwhile, it’s being said that his criticism of Georgia Republicans may hurt their prospects in January.
[xix] Not to mention a number of other measures aimed at increasing tax revenues. https://www.taxlawforchb.com/2020/08/bidens-tax-proposals-for-capital-gain-like-kind-exchanges-basis-step-up-the-estate-tax-tough-times-ahead/ ; https://www.taxlawforchb.com/2020/08/responding-to-the-democratic-partys-tax-plans/ .
It should be noted that the top estate/gift tax rate in 2009 was 45%. Since 2013, that rate has been set at 40%.
[xx] A grantor trust, at that; in case you want to reacquire the interest down the road without adverse income tax consequences. Mind you, Mr. Biden’s plans call for changes regarding the interplay of the grantor trust and estate/gift tax rules.
[xxi] If you’re a New York resident, you need to survive for three years after the gift in order to remove the gifted property from your New York gross estate.
[xxii] Let’s not forget the generation-skipping transfer tax. Chapter 13 of the Code.
[xxiii] SBA Procedural Notice, Control No. 5000-20057, October 2, 2020.
These “change of ownership rules” do not apply to a PPP borrower if, prior to closing the sale or transfer, the borrower (a) has repaid the PPP loan in full, or (b) has completed the loan forgiveness process and either (i) the SBA has remitted funds to the PPP lender in satisfaction of the loan, or (ii) the borrower has repaid any remaining balance of the loan.
[xxiv] Other “change in ownership” events include the sale or other transfer by a PPP borrower of at least 50% of its assets (by fair market value) in one or more transactions, and the merger of a PPP borrower with another entity.
[xxv] In all cases, the Notice reminds us, the PPP borrower remains subject to all of its obligations under the PPP loan. In addition, if the new owners use the borrower entity’s PPP funds for unauthorized purposes, the SBA will have recourse against them for such use.
[xxvi] The aggregation rule described earlier also applies for this purpose.
A transfer of less than 20% is not subject to these rules. That being said, the lender’s loan agreement may contain certain restrictions on transfers of which the borrower and its owners should be aware.
[xxvii] After the forgiveness process is completed, the escrow funds must be used to repay any remaining unforgiven PPP loan balance (plus interest) before being returned to the borrower.
[xxviii] Something like a swap.
[xxix] Sale vs gift, for example.
[xxx] “A date which will live in infamy.” https://www.loc.gov/resource/afc1986022.afc1986022_ms2201/?st=text .
[xxxi] If Mr. Trump held on to the White House, he would have been in a position to veto any tax increases coming out of Congress because it was almost impossible that the Democrats would secure veto-proof majorities in both chambers.