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Paycheck Protection Loan Update

Many recipients of PPP loan proceeds are now at the point where they are beginning the process of applying for loan forgiveness

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Insights  <  Paycheck Protection Loan Update - October 22, 2020

Many recipients of PPP loan proceeds are now at the point where they are beginning the process of applying for loan forgiveness

Many recipients of Paycheck Protection Program (PPP) loan proceeds are now at the point where they are beginning the process of applying for loan forgiveness. The U.S. Small Business Administration (SBA) has recently issued additional guidance on PPP loan forgiveness through the Interim Final Rule (IFR) on Appeals of SBA Loan Review Decisions under the PPP (8/11/20), the Interim Final Rule on Treatment of Owners and Forgiveness of Certain Nonpayroll Costs (8/24/20), Frequently Asked Questions (FAQs; 8/11/20), and Frequently Asked Questions on Loan Forgiveness (8/11/20). Within this large swath of information, there are some key takeaways that prove especially helpful with regard to owner-employees, eligibility of certain rental and mortgage interest payments, and related-party rent.

For starters, the SBA offered clarification with regard to exceptions as owner-employees. In particular, individuals with a less than five percent ownership stake in a PPP borrower that is a C- or S-Corporation are not subject to the owner-employee compensation rule when determining the amount of their compensation that is eligible for loan forgiveness.

The SBA also recently clarified that amounts attributable to the business operation of a tenant or sub-tenant of the PPP borrower—or, in the context of home-based businesses, household expenses—are not eligible for forgiveness. The amount of loan forgiveness requested for nonpayroll costs may not include any amount attributable to the business operation of a tenant or sub-tenant of the PPP borrower or, for home-based businesses, household expenses.

Specifically, in the case where a portion of a rented office building is leased to other businesses, only the amount of the lease minus the rent from the sublease is eligible for loan forgiveness. Similarly, if a borrower has a mortgage on an office building it operates out of, and leases out a portion of the space to other businesses, the portion of mortgage interest that is eligible for loan forgiveness is limited to the percent share of the fair market value of the space that is not leased out to other businesses. If a borrower shares a rented space with another business, the borrower must prorate rent and utility payments in the same manner as on the borrower’s 2019 tax filings (or if a new business, the borrower’s expected 2020 tax filings) when determining the amount that is eligible for loan forgiveness. Finally, if a borrower works out of his or her home, the borrower may include only the share of covered expenses that were deductible on the borrower’s 2019 tax filings (or if a new business, the borrower’s expected 2020 tax filings) when determining the amount of nonpayroll costs that are eligible for loan forgiveness.

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The SBA also addressed related-party rentals, capping eligible expenses based on only the mortgage interest owed on the property during the covered period. It also appears that any common ownership between the lessor and the lessee is enough to trigger this limit. As long as the amount of loan forgiveness requested for rent or lease payments to a related party is no more than the amount of mortgage interest owed on the property during the covered period that is attributable to the space being rented by the business, and the lease and the mortgage were entered into prior to February 15, 2020, rent payments to a related party are eligible for loan forgiveness. Any ownership in common between the business and the property owner is a related party for these purposes. The borrower must provide its lender with mortgage interest documentation to substantiate these payments. While rent or lease payments to a related party may be eligible for forgiveness, mortgage interest payments to a related party are not eligible for forgiveness.

Still, there is a lack of clarity around the issue of deductibility of expenses that are reimbursed with the proceeds of a PPP loan. Earlier in the year (April), the IRS issued Notice 2020-32 stating expenses reimbursed by a forgiven PPP loan will not be allowed as a tax deduction. Specifically, the IRS noted that statutory and regulatory language in Internal Revenue Code 265 cause the PPP expenses to be treated as non-deductible. This, in effect, would increase the taxable income of an eligible borrower that has a PPP loan forgiven by the amount of the loan that is forgiven. Subsequent to the IRS issuing Notice 2020-32, the lawmakers that drafted the original CARES Act bill specifically stated it was not their intent that forgiveness of a PPP loan would result in additional taxable income to an eligible borrower.

Notice 2020-32 has been heavily criticized by tax professionals and lawmakers because the position taken in the Notice appears to ignore the overarching intent of the PPP, as well as the specific intent of Congress to allow deductions in the case of PPP loan recipients. In fact, on May 5, 2020, in a show of strong bipartisan support, the chairmen of the Senate Finance Committee and the House Ways and Means Committee (Republican Senator Grassley and Democratic Representative Neal) issued a strongly worded letter to Treasury Secretary Mnuchin expressing the intent of Congress in drafting the CARES Act and in the inappropriateness of the IRS Position.

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Following a release of that letter, a bipartisan group of senators introduced the Small Business Expense Protection Act to directly overturn the IRS position and clarify with a legislative fix that “no deduction shall be denied or reduced…” due to the exclusion of the loan forgiveness from gross income. While it has been reported that the bill has strong bipartisan Congressional support, it has yet to be voted on as a stand-alone bill. However, most professionals and lawmakers are expressing optimism in the ultimate passage of S. 3612 as part of a future relief package, which would settle the PPP expenses deductibility debate. As of the date of this article, there is no express law that would allow the deductibility of such expenses.

Affected taxpayers may want to delay filing 2020 tax returns until the extended due date while we await additional guidance/legislative action, ensuring that PPP loan proceeds remain as helpful as intended.

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