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IRS Issues Ruling on Paycheck Protection Program Forgiveness

IRS Issues Ruling on Paycheck Protection Program Forgiveness

This week, the Internal Revenue Service issued guidance on PPP loan forgiveness via Revenue Ruling 2020-27, which can be found here: https://www.irs.gov/pub/irs-drop/rr-20-27.pdf. Don’t worry, I will summarize it for you with examples. First a little background.

BACKGROUND

In April 2020, Congress passed the CARES Act that allowed for a Paycheck Protection Program (PPP) loan from the Small Business Administration (SBA). If used properly, those loans may be forgiven and not required to be repaid. At the same time, the SBA began issuing Economic Injury Disaster Loans (EIDL). The EIDL loans are required to be paid back. However, the SBA issued an emergency advance on that loan to applicants equal to $1,000 for every employee on the payroll, up to $10,000. This advance is not required to be paid back.

HOWEVER…

If you received both the PPP loan and the EIDL Advance, you will have a loan to repay. The EIDL Advance will reduce your forgiveness on the PPP dollar for dollar. For example, if your PPP loan was $100,000, and you received an EIDL Advance of $8,000, your potential forgiveness for the PPP loan is $92,000.

PPP Loan Proceeds                          $100,000

Less:  EIDL Advance                             (8,000)

Maximum PPP Forgiveness           $  92,000

On May 2, 2020, the IRS released Notice 2020-32 which clarified that NO DEDUCTION IS ALLOWED for any eligible expense if the payment of that expense results in forgiveness of a covered loan.

Translation: If you received a PPP loan and used it to pay salaries, then had that loan forgiven, those salaries are not deductible on your tax return.

 

Under the terms of the CARES Act, the forgiveness of the loan will not be treated as taxable income to you. Therefore, technically, you did not pay for the salaries mentioned in the previous paragraph and cannot deduct it on your tax return.

This was the first time we learned the PPP loans would increase tax liabilities.

On June 5, Congress expanded the scope of PPP funds usage and increased the covered period through the end of the year. As the months dragged on without any further movement from Congress on the matter, banks across the country dragged their feet on offering forgiveness application portals to their borrowers. Of the few that did accept forgiveness applications, the SBA took 90 days or longer to approve them.

THE ACCOUNTING ISSUE

Fast-forward to October. PPP loans are starting to come due. Banks don’t know what to do and are not prepared for forgiveness applications to begin flooding in. Congress is busy with things that have nothing to do with this loan package. Accountants across the country are scratching heads.

What do we do if the loan expenses are in one year and the forgiveness is in another? The PPP loan money has all been spent as instructed. Forgiveness applications are elusive, and taxpayers have to begin preparing for their 2020 income taxes to ensure they have enough tax paid in.

IRS REVENUE RULING 2020-27

Rev. Rul. 2020-27 states:

“A taxpayer that received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.”

Translation:  If you have a PPP loan and plan to apply for forgiveness now or in the future, you may not deduct the expenses paid with those funds in 2020.

WHAT DOES THIS MEAN FOR YOU?

Months ago, I wrote a blog post about how to restructure your chart of accounts to separate the expenses paid with PPP loan proceeds. Regardless of whether you changed your chart of accounts around or something similar, consider taking the following steps.

  1. Make a decision about your company books.
    1. Do you want your Income Statement (P&L) to reflect normal operations and show the non-deductible expenses for management use and budgeting? OR
    2. Do you want your accounting system to reflect your income tax filings?

There are good arguments for both situations. I have no intention of trying to persuade you in one direction or another. Neither is right nor wrong. Once you decide, continue on for further steps.

  1. Get a tax projection completed now. We now know that the expenses in 2020 will not be deductible in 2020. If you have not planned for this before, this will dramatically affect your taxable income for 2020. Before getting caught with an extra $100,000 in net taxable income, you need to know how this will change your taxes. Here is an example of the potential impact.
    Tax Based on 2020 Rates
    2020 Net Operating Income Before Forgiveness $  85,000.00 $ 11,762.00
    Reduction of Expenses (PPP Loan Forgiveness)     92,000.00
    EIDL Advance Received       8,000.00
    2020 Taxable Income $185,000.00 $ 36,247.50
  2. If you received the EIDL Advance, be sure to record that as Other Income on your Income Statement. This money is taxable.
  3. If you choose 1a, prepare a schedule of non-deductible expenses to present to your tax preparer at tax time and keep it with your permanent income tax records so you have a clean “Book-to-Tax” reconciliation to refer to years from now when you wonder why your income tax return shows higher income than your accounting system.
  4. If you choose 1b above. Read on for specific suggestions for your accounting system.

PREPARE YOUR ACCOUNTING SYSTEM

For the following, we will assume:

PPP Loan of $100,000

EIDL Advance of $8,000

Year-to-Date Salary Expense of $250,000

  1. Create a Long-Term Liability account called PPP Loan Payable.
  2. Reclassify your PPP loan proceeds to that account, if it is not already there.
  3. Create an Other Income account called EIDL Advance
  4. Reclassify your EIDL Advance to the new account, if it is not already there.
  5. Calculate your potential forgiveness. For simplicity, we will assume the entire loan is forgivable except for the EIDL Advance.
  6. Reduce the PPP Loan Payable account by the amount of potential forgiveness.

Debit PPP Loan Payable $92,000

Credit Salaries Expense  $92,000

  1. Check the ending balances
    1. PPP Loan payable $8,000
    2. EIDL Other Income $8,000
    3. Salaries Expense $158,000

FREQUENTLY ASKED QUESTIONS

QUESTION ANSWER
What if my loan forgiveness is denied or I decide to just pay back the loan? Rev. Proc 2020-51 provides a safe harbor to allow those expenses to be deducted.
Is the EIDL Advance Taxable? Yes, in all cases the EIDL Advance is Taxable Income
Is the EIDL Taxable? No, the EIDL is a loan that must be repaid and is not taxable.
I received CARES grants from my state/local government. Are they taxable? Yes, those grants are taxable income

Managing Your PPP Loan for Maximum Forgiveness

Congratulations! You are one of the lucky recipients of the Paycheck Protection Program Loan. Not everyone can say the same. Once you receive approval, the bank has ten calendar days to disburse the money. As soon as you receive those funds, the 8-week clock begins to tick. Do not waste time.

For the eight weeks immediately following your loan funding, your expenses must meet certain criteria if you hope to have the loan forgiven. Loan forgiveness is not automatic. You will have to apply for it prior to repayment in six months. Currently, there are no guidelines for the forgiveness application. They will share that information as they develop it.

Using the Loan Proceeds

The entire purpose of the PPP Loan is to maintain payroll. Naturally, using the money for payroll is high on the government’s agenda. Therefore, you must use 75% or more of the money for payroll costs. If payroll costs in the eight-week period do not exceed 75% of the loan proceeds, the amount of loan forgiven will be reduced by the shortage. Payroll costs include:

  • Salary, wages, commission, and similar compensation
  • For Partnerships – Guaranteed Payments to Partners AND partner’s share of income subject to self-employment tax
  • Vacation, sick, family leave
  • Severance pay
  • Group health insurance premiums
  • Company portion of retirement benefits
  • State and local tax assessed on employee compensation, such as unemployment, SDI, etc.

WARNING: You may think, well, if I cannot make the 75% in regular payroll, I’ll just bonus myself the difference. Be very careful about unusually high bonuses or commissions to trick the system. You will need documentation. I anticipate random audits and reviews of PPP loan proceeds over the next two years. Free money from the government is a prime opportunity for rampant fraud.  Additionally, your employee count must not dip below 25% of your January 31, 2020 employee count.

Not more than 25% of the loan forgiveness may be attributable to non-payroll costs, such as rent, utilities, and mortgage interest. All expenses made in the eight-week period must be for “costs incurred and payments made” within that eight-week period. While this hasn’t been clearly defined, we can assume that you cannot pay your rent six months in advance with the money, nor pre-pay your utilities.

TIP: If you have rent, mortgage, or utilities on autopay, take them off now. Be sure to pay the bills inside the eight-week period for periods included in that eight-week period.

Documentation

If you do not keep accurate time records of your employees’ work, now is a great time to start. You will need proof of commissions, bonuses, pay raises, and vacation/sick time. You will also need to prove that any time off does not overlap with the payroll tax credits of the Families First Coronavirus Response Act (FFCRA). Have all time accurately recorded. Salaried employees do not need to keep time unless they are taking paid time off. Those hours should be clearly documented as to the purpose and length of leave. The FFCRA has more detailed documentation requirements for the employment credits.

Keep and store copies of your rent and utility bills. Utilities include gas, water, electric. Utilities do not currently include internet or cloud hosting at this time. You are required to maintain these records for four years.

Update Your Accounting System

Create a separate account in your accounting system for COVID-19 Expenses and create a list of sub-accounts. Here is a picture of mine:

Be very careful over the eight-week period to carefully post information into the correct category. You want to be able to easily run reports to track your expenses for forgiveness. A quick rundown of the sub-accounts above.

  • Employee Family Leave and Employee Sick Leave were created to track FFCRA time off for employment credits. You must keep this separate from other payroll records.
  • Group Health and Salaries are to track payroll in the eight weeks separate from payroll in the other parts of the year.
  • Rent and Utilities for tracking those expenses during your eight weeks and separating it from other regular expenses
  • Optional items for your use only are Internal Costs and MSP Tools for Customers. You will not use these for loan forgiveness, but items purchased specifically for the pandemic can be tracked here to not interfere with other metrics in future/past years for comparison purposes.

Forgiveness – What to Expect

There is another really great reason to separate these expenses. The portion of the loan that is forgiven is technically income to you. The federal government has stipulated this will not be taxable for federal tax purposes. Sounds great, right? Of course! However, there are other considerations.

Be aware that not all states follow the Internal Revenue Code and unless your state specifically excludes the loan forgiveness, you may find yourself paying state income taxes on it.

Also note that it is entirely possible that the expenses that allow the forgiveness of the loan may not be deductible on your tax return, thereby making the loan a complete wash. You (or your tax preparer) will want a nice easy way to find the expenses that are not deductible. Using my method above will go a long way to identify the non-deductible expenses.

It is not clearly stated at this point if those expenses will be non-deductible. At the same time, it is not clearly stated that they will be. We can expect future guidance from the Internal Revenue Service on this. Until then, play it safe and segregate your costs as much as possible. It’s better to be over prepared and not need it, than need it and not be prepared at all.

 

Stay safe out there!

CARES Act Stimulus Strategy

Now that countries around the world have stimulus packages in place, what is the best use of that money and opportunity?

In the United States, our government passed two packages in the past month. Your head may be spinning with the best course of action for your business. I have some suggestions. But first, allow me to offer a quick glossary of terms:

FFCRA – Families First Coronavirus Response Act – passed March 18, provides paid sick and family leave for your employees for up to 80 hours.

CARES Act – Coronavirus Aid, Relief, and Economic Security Act, passed March 27, 2020 to maintain businesses and workers.

PPP – Paycheck Protection Program – included with the CARES Act, provides forgivable loans to cover payroll expenses and other necessary business expenses.

EIDL – Economic Injury Disaster Loan – included with the CARES Act and provides immediate relief for payroll and business expenses. You can apply for this today at: https://covid19relief.sba.gov/#/

 

Prepare Documentation for Loans

Regardless of which program you choose to help your business, your company finances will need to be in order. Some loans will require documentation prior to offering a loan, others will require documentation after you use the funds. This article is to help you prepare. Contact your favorite banker and place them on notice that you want to apply for relief. They may be able to give you a list of documentation they will require. If not, use mine.

You will need proof of expenses, so your accounting system must be in order. If it is not, you have a small window of opportunity to get it ready while the SBA, states, and other agencies build guidelines in the coming weeks.

You will need to provide proof of payroll from 2019. The number of employees, the average monthly payroll cost, and average monthly payroll taxes for three months between February 15, 2019 and June 30, 2019.

You will need tax returns for the past two years. If you have not yet filed your tax returns, do so as quickly as possible. Additionally, you will need to provide support for rent payments, mortgage payments, and utility payments. Start now so you are ready when the banks are ready to help you.

 

Begin Tracking COVID-19 Expenses

Consider creating a bucket of expenses in your accounting system to track all expenses related to COVID-19. In this bucket, you should have some subaccounts:

  • Employee Sick Leave
  • Employee Family Leave
  • Salaries and wages
  • Payroll taxes
  • Health insurance premiums
  • Rent/Mortgage interest payments
  • Utilities
  • MSP Tools

You will need to separately track your payroll for COVID-19, especially if you obtain a PPP loan. Additionally, the FFCRA requires a separation for paid sick and family leave. These two items will be treated differently for the tax credits. Use your PSA or whatever time tracking system you use to manage this. Create a code for C-19 Sick/FML. This will help you obtain the proper credits for wage reimbursement un FFCRA. Create another code to track worked hours during the covered periods for PPP and EIDL. You will need to support your claims if you plan to apply for loan forgiveness.

Speaking of loan forgiveness, do not apply for these loans with the expectation they will be forgiven. Expect to pay them back and be pleasantly surprised if you later do not have to. This is not guaranteed free money.

The remaining expenses are self-explanatory, except for the MSP Tools. Many MSPs are helping their customers move employees to home-based work. This may include the offering of RMM seats, anti-virus, web security, and other tools you will use to keep them secure and patched. If you are not charging your customer for those extra seats as a gesture of goodwill, or even expectation, place those costs here. You may also want to track any internal expenses your company incurs in a separate expense account. At the end of this year, you should have a very clear picture of how much COVID-19 cost your business.

 

Develop a Strategy

The best course of action is to develop a strategy for using these funds. Consider creating a separate bank account for the money and use it for its intended purposes. For the PPP loan, your company expenses will be analyzed for the eight-week period following the loan origination date. The dollars you spend on payroll, utilities, rent, or mortgage interest will be added together for the forgiveness total.

Any remaining amounts of loan that were not used for those purposes will enter into a repayment schedule. However, if your company lays off employees, who make less than $100,000, during that eight-week period, the loan forgiveness will be reduced by the amount of the pay cut. If you have employees that you are considering letting go, do so before obtaining the loan so they will not interfere with your program.

While the PPP loan is paying your business-critical expenses, consider using the money you would have spent on payroll and rent to aggressively pay down existing debt, or increase marketing.

Develop a system for marking expenses for COVID to get them entered properly.

Meet with your accounting team and accounting professionals to build a plan that will use this money to keep your company running efficiently in the coming months. Develop a budget to only spend where necessary. Keep your eye on the budget and do everything you can to stay within it.

Stay safe. Stay healthy. Stay sane.

MSPs: Stay Ahead of the Curve

As the global pandemic brings business and the economy to a grinding halt, you may wonder what steps you can take now to protect your business, your employees, and your customers. CISA.gov lists the Information Technology Sector as one of 16 critical infrastructure sectors needed to stay open and operable during a national crisis. Here are some steps you can take right now to alleviate stress on your business.

Payroll

The IRS outlined provisions for the Families First Coronavirus Response Act (FFCRA). The new law will take effect on April 2, 2020 and remain in effect until December 31, 2020. Here is a quick rundown of the provisions. Consider finding a way in your PSA or payroll system to track COVID-19 related leave separate from normal PTO.
– For COVID-19 reasons, employees receive up to a maximum of 80 hours paid leave
– Employers receive 100% reimbursement for the wages
– Employers face no payroll tax liability
– Self-Employed individuals receive an equivalent credit
– Employers with fewer than 50 employees are eligible for an exemption, but can voluntarily comply. Employers with 50 – 500 employees are mandated to comply within 30 days. Employers with over 500 employees do not qualify for the credit.

Complete details can be found in IR-2020-57 at: https://www.irs.gov/coronavirus. If your employees are forced out of work, please take advantage of this program to keep them paid.

Income Taxes

The IRS has announced the April 15 tax filing date has been moved to July 15, 2020. If your return has been filed and you wish to cancel your automated payment, you can call the IRS e-file Payment Services at 1-888-353-4537. This is an automated service available 24 hours a day, 7 days a week. This relief also includes estimated tax payments for 2020 that are due on April 15. Take advantage of this extra time to save for the tax balance due. Contribute to a SEP or IRA, since those deadlines are extended, too.
For information on your state income tax response, please see this link: https://www.taxadmin.org/state-tax-agencies.

Inventory Purchases

Dust off your crystal ball and peer into the future for this one. There are two possible outcomes that will invoke Economics 101 – Supply and Demand. Hardware and computer supplies may become limited and pricing could return to that of a 1991 personal computer. Therefore, it may be tempting to stock up on computers now when the price is low. However, if the economy continues to sink, you could be left holding those computers with no one to sell them to. It may be a waste of valuable company resources.

Reduce stock and inventory purchases to keep on hand. You may need that cash in the coming weeks. Consider keeping only one or two computers on hand for a quick turnaround. Otherwise, only order equipment that your customers have paid for.

If you are not already doing this, immediately implement a policy in your company to collect on all hardware invoices prior to ordering. Now is not the time to extend credit needlessly. You will only harm yourself by charging the purchase to a credit card and paying interest on those charges if your customer slow-pays the invoice. If they want to slow-pay the invoice, they can slow-wait for the hardware.

The End of AYCE Managed Services

For those working around the clock to get your customers’ employees set up to work remotely from home, this is for you. You may have an all-you-can-eat managed service agreement that covers everything, and you may struggle with whether you should charge your customers for this extra work that no one saw coming.

The answer is, “Yes! Absolutely charge them.” These are new installations, new connections, and far outside the normal course of your managed services agreement. To be expected to connect 100 remote workers in 48 hours for free is unreasonable.

Explain to your customers how securing remote connections and the home offices of their employees is time-consuming and you want to devote all the resources possible to getting it right. This cannot be done for free. Offer to spread the cost over future months if it will help the customers, but remind them that you are still required to pay your people overtime for working to keep them safe and operational.

We already knew that the all-you-can-eat concept is going out of style. This pandemic may pave the way for AYCE to go the way of the leisure suit.

Check Your Subscriptions

You should do this on a regular basis anyway. Review the subscriptions you purchase and make sure you have a customer being invoiced for it. Often, we switch subscriptions like AV or security and fail to cancel the old vendor when the new one is implemented. Check each vendor to ensure you have a legitimate reason for sending them money each month. Are the bills accurate? Do you have any services you can consolidate for a lower monthly cost?

Stay Connected with your Financials

With so many other things needing our attention, it is easy to let your accounting system go. Don’t do it. If there is a problem with profits, you want to know that now, not later. Stay on top of the accounting reports, financial metrics, and any slump in revenue. Any changes should be scrutinized and corrected as quickly as possible.