Department of Business Oversight’s New Name

The California Department of Business Oversight has officially changed its name to the Department of Financial Protection and Innovation (DFPI). The department name change became effective September 30, 2020.

While the DFPI has yet to set a firm deadline for updates to loan documents, business cards, or websites, licensees should complete this legally required transition as soon as possible.

During the transition period, the DFPI will continue to recognize existing materials with the “Department of Business Oversight.” The department recognizes it may take time to incorporate any/all legally required disclosures, documents, printed materials, and website information provided to consumers, other regulators, or to the public.

Additionally, please note that the department’s Sacramento headquarters address has changed to 2101 Arena Boulevard, Sacramento, CA 95834. Please contact California Financing Law Special Administrators with any specific challenges.

For questions, please contact the appropriate department program or email Ask.DBO@dbo.ca.gov

Tax Relief for Victims of California and Iowa Disasters

The California wildfires and the Iowa derecho that occurred this summer have wreaked havoc on area residents. While federal disaster relief is available, the IRS recently released information on assistance it may offer. According to the IRS, victims of the latest California wildfires and the August 10th Iowa derecho now have until December 15, 2020 to file individual and business tax returns and make payments. It is not necessary for taxpayers to indicate on the return they are in a disaster zone. The IRS will automatically provide filing and penalty relief to any taxpayer within these disaster areas.

FEMA designated the following areas for disaster relief: Linn County in Iowa and Lake, Monterey, Napa, San Mateo, Santa Cruz, Solano, Sonoma, and Yolo counties in California. Any additional areas added to disaster relief status will automatically be provided the same relief. An updated list of affected localities can be found on the disaster relief page at IRS.gov. In the event an affected taxpayer does receive a penalty notice, the IRS recommends calling the number on the notice to have the penalty abated.

Taxpayers with a valid extension to file their return by October 15, 2020 will now have until December 15, 2020 to file their tax returns and make payments due during this time period. The IRS noted that tax payments related to 2019 returns that were due on July 15, 2020 are not eligible for this relief.

The December 15, 2020 deadline also applies to quarterly estimated income tax payments due on September 15, 2020, and the quarterly payroll and excise tax returns normally due on October 31, 2020. It also applies to tax-exempt organizations, operating on a calendar-year basis, that had a valid extension due to run out on November 15, 2020. Businesses with extensions also have the additional time including, among others, calendar-year corporations whose 2019 extensions run out on October 15, 2020.

Individuals and businesses in a federally declared disaster area who suffered uninsured or unreimbursed disaster-related losses can choose to claim them in the year the loss occurred (2020) or in the prior year tax return (2019). These returns must have the FEMA declaration number on any return claiming the loss: 4558 for California or 4557 for Iowa. See Publication 547 for details.

For information on disaster recovery, visit disasterassistance.gov.

Reminders for REITs on Prohibited Transactions

Reminders for REITs on Prohibited Transactions was originally published in AAPL’s Summer Edition 2020 Private Lender Magazine.

The passage of the Tax Cuts and Jobs Act led to an increase in the number of private lending funds converting to mortgage REITs over the past two years. Fund managers made the conversion decision by carefully weighing whether the tax benefits of the Section 199A 20% Qualifying Business Income Deduction outweighed the increased compliance costs associated with operating a REIT.

Due to the current pandemic, it is important to be circumspect when administering your REIT.

Loan payment delays or forbearances may be indicative of upcoming loan modifications or foreclosures, which could disqualify the private lending entity’s REIT status. To maintain REIT status, the REIT may need to make investment decisions that might reduce stockholders’ overall return and alter investment objectives but would keep the REIT election safe. Loss of REIT status would lead to the mortgage REIT reverting to a C corporation, resulting in unfavorable tax treatment. The C corporation would pay tax at a 21% tax rate, and the dividend payments issued to investors would be taxed a second time at the investors’ income tax rates, resulting in double taxation.

Loan Modifications
Loan modifications or foreclosures could result in REITs failing to meet the required income or asset tests. If loan modifications or foreclosures within a REIT do not meet safe harbor guidelines, they may result in prohibited transactions. Loss of REIT status may occur if IRS regulations are not met. There are workable solutions around these matters if the manager is proactive and plans to avoid problems.

Prohibited Transactions for REITs and Safe Harbor Rules
REITs are required to pay a 100% tax on net income generated from prohibited transactions. These transactions may arise when a loan is foreclosed on and leads to the sale of a real estate owned asset if that property is considered to be held as inventory or primary sale to customers. Exceptions may be made when the fair market value (FMV) of the property sold in a year does not exceed 10% of the aggregate tax basis or aggregate FMV of REIT assets at the beginning of the year.

Fund managers with mortgage REITS and borrowers in default need to be more diligent during our current economic state. IRS safe harbor rules provide relief in situations where a REIT might engage in a prohibited transaction if REIT compliance is not met.

To ensure these rules are satisfied:

  1. The property held to produce rental income must remain in the REIT for at least two years.
  2. Any accumulated expenditures made through the REIT, during the two-year duration, may not exceed 30% percent of the property’s net sale price.
  3. The REIT: (a) made no more than seven property sales during the year; (b) during the tax year, the aggregated adjusted bases of the property does not exceed 10% of the aggregate adjusted basis of all assets held by the REIT as of the beginning of the year; (c) the FMV of property sold does not exceed 10% of the FVM of the total REIT assets as of the beginning of the year.
  4. If the property consists of land or improvements not acquired through foreclosure or lease termination, the REIT has held the property for at least two years for the production of rental income.
  5. If the seven-sales property rule related to Sec.(b)(C)(iii)(I) (item 3(a) above) is not met, substantially all of the marketing and development expenditures relating to the property sold were met through an independent contractor or taxable REIT subsidiary from whom the REIT receives no income.

Dealer Versus Inventory
To distinguish between inventory and investment property, a REIT may take the position that the property sold was not inventory and the REIT is not a dealer of property assets. If it were determined that a REIT sold dealer property, that would be considered a prohibited transaction. Essentially, property or inventory held primarily for sale as part of its business model is not considered a capital asset.

Income from a Foreclosure Property
If the REIT does not follow IRS guidelines, income from a foreclosure property will be taxed at the highest rate by multiplying the net income from the sale of the foreclosed property by the highest rate specified per tax code. Tax will be imposed for each taxable year on the net income from a REIT liquidating a foreclosure property asset.

Sales of assets of a REIT that do follow a liquidation plan would not be considered prohibited transactions under tax code Section 857(b)(6). The IRS ruled that if the taxpayer previously expressed that he or she intended to hold the assets or properties for a minimum number of years, yet now sees a long decline in asset value and has explored alternatives to hold on to the properties, the REIT may pursue a complete liquidation.

REIT Qualifications
To qualify as a REIT, an entity must meet two annual income tests (among other requirements). The REIT must:

  1. Invest at least 75% of the assets in real estate related income.
  2. Derive at least 75% of taxable income from rents or mortgage interest.
  3. Disperse a minimum of 90% of gross taxable income to shareholders each year in the form of dividends.
  4. Maintain a minimum of 100% of its shareholders after the first year of existence.
  5. Ensure no more than 50% of its shares may be held by five or fewer individuals during the last half of each taxable year.
  6. Have no more than 20% of its assets consist of stocks in taxable REIT subsidiaries.

Make sure to consult your tax adviser, as a REIT may be subject to some federal, state and local taxes on property, even if the REIT qualifies as a REIT under federal tax guidelines. If the mortgage REIT has a loan in default, which the fund manager feels will result in a loan modification or foreclosure, carefully review the REIT qualifications and safe harbor rules to mitigate any risk of loss of REIT status or of engaging in a prohibited transaction.

IRS Rules on Deductions & Expenses Regarding Your PPP Loan

Have you considered taking a deduction on your expenses paid with PPP funds?

While it might be tempting, the IRS considers this double-dipping. Standard business deductions are not allowed by the IRS if payment of those expenses also results in PPP loan forgiveness.

Under the CARES Act, PPP loans for small businesses can be totally forgiven provided the funds are primarily used to retain employees, among meeting other requirements. However, CARES Act guidelines also state loan forgiveness is not tax-deductible. The forgiveness of your loan will result in a “class of exempt income” under 1.265(b)(1) of the Regulations.

According to Treasury Secretary Steven Mnuchin, “The money coming in the PPP is not taxable. So, if the money that is coming is not taxable, you cannot double-dip. You cannot say that you’re going to get deductions for workers that you did not pay for.”

Mnuchin stated that he had personally reviewed the IRS guidance and if the loan forgiveness had been deemed taxable, business deductions would be allowed. “This is basically tax 101,” said Mnuchin.

Many lawmakers have expressed a desire to re-address these guidelines in future legislation since the intent of the PPP loan program was to help small businesses maximize their ability to maintain fluidity, retain employees, and recover from this crisis as best possible. It is quite likely that IRS guidelines on tax exemption may be specifically addressed in any new coronavirus-related legislation to clarify the original intent of the PPP loan program under the CARES Act.

Link to IRS document.

The PPP Loan Program Extended

The Paycheck Protection Program (PPP) resumed accepting applications on July 6th, following the President signing the program’s extension over the July 4th weekend. According to the Small Business Association (SBA), approximately $130 billion allocated for PPP was left untapped once the original June 30th deadline expired. Small businesses now have an additional five weeks to apply for loans or until August 8th.

 

The SBA reported that 4.8 million businesses received funds, totaling $520 billion of the original $670 billion PPP funds authorized by Congress this past March. Businesses with fewer than 500 employees may apply for a PPP loan through any existing SBA 7(a) lender or FDIC bank, federally insured credit union, and Farm Credit System institution that is participating in the program.

 

Total loan forgiveness is available to businesses who prove they have suffered a 50 percent or more revenue loss, due to the pandemic. Additionally, at least 60% of the PPP funds must be spent on payroll costs, while the other 40% may be allocated for assistance with rent, utilities, and interest on mortgages.

 

Congress is expected to address further emergency relief funding in late July, as well as ways to repurpose any leftover funds. Lawmakers have also discussed the possibility of permitting businesses with fewer than 100 employees to apply for a second loan, as well as sole proprietorships and self-employed individuals, provided they have exhausted their original PPP loan.

Link to the SBA Application.

IRS Expands Eligibility on COVID-19 Distributions from IRAs

The IRS expanded its guidelines on June 20th with Notice 2020-50 that allows additional qualified individuals to take a coronavirus-related distribution (CRD) while avoiding the usual restrictions on early IRA distributions. Under the CARES Act, qualified individuals may receive favorable treatment for IRA distributions up to $100,000 from eligible retirement plans (i.e. 401k/403b and 457s) until December 31, 2020. Additionally, the 10% tax on early distributions is waived for any CRD if the distribution is taken before the account holder reaches 59 ½.

The Notice expands eligibility of “qualified individual” under the CARES Act

The original Act indicates a qualified individual is someone diagnosed with COVID-19, whose spouse or dependent is diagnosed with COVID-19 by a CDC approved test or a person who experienced adverse financial consequences resulting from being quarantined, furloughed or laid off or having hours reduced, unable to work due to lack of child care or closing or reduced hours for a business owned by the individual, any as a result of COVID-19.

The definition of “qualified” was expanded to include the individual and/or spouse, or a member of the individual’s household who had a job offer rescinded or start date delayed due to COVID-19. Additionally, a qualified individual includes someone whose income is affected by COVID-19 because a spouse or other household member (sharing the principal residence) experienced an income reduction due to COVID-19.

Also qualifying are household members unable to work due to lack of childcare because of COVID-19, as well as business owners/operators who lose income due to closing or reducing hours of business due to COVID-19.

Notice 2020-50 clarifies that while it is optional for employers and plans to designate distributions as COVID-related, qualified individuals whose distributions meet the above requirements will still receive this favorable federal tax treatment, even if a distribution is not classified as a CRD by the employer.

The CARES Act also provides somewhat of a tax holiday to a Qualified Individual

While a distribution from a qualified retirement plan is generally included in taxable income in the year of distribution, the CARES Act permits a qualified individual to include a CRD in taxable income ratably over a three-year period.  Notice 2020-50 clarifies this is an election on the part of the qualified individual who may choose instead to include the entire CRD in taxable income in the year of receipt; however, this election may not be changed. All CRDs must be treated in the same manner as reflected on the qualified individual’s 2020 tax return.

Additionally, the CARES Act permits a qualified individual to re-contribute a CRD to a qualified retirement plan. Unlike the tax treatment of a CRD, whether a CRD will be re-contributed to a qualified retirement plan or the manner in which it will be re-contributed, does not have to be determined before the filing of the qualified individual’s 2020 tax return.  Notice 2020-50 says that the decision can be made at any time during the three-year period and provides for the filing of amended returns to reflect the re-contribution of all or a portion of the CRD.

Link to IRS Notice 2020-50

Spiegel Joins National Lending Experts

The National Lending Experts (NLE) recently announced Jeff Spiegel as the CPA/Business Advisor, and newest member, of its Advisory Board. Jeff accepted the invitation to contribute to the NLE network and offer leadership in the areas of tax, accounting, audit, and business consulting.

The NLE established itself to provide core leadership and guidance by offering up-to-date information and education on market conditions and trends via virtual platforms and national events. The organization is committed to connecting industry professionals with leadership and direction as it pertains to every aspect of the real estate industry, including residential and commercial lending, servicing, valuation, secondary markets, litigation, rehab/construction, and best practices.

Jeff looks forward to collaborating with his fellow Advisors by providing valuable resources to further industry success.

Learn more about The National Lending Experts.

COVID-19 Relief Under the Stafford Act

The President issued an emergency declaration in response to the coronavirus pandemic under the Stafford Act and subsequently approved major disaster declaration requests under Sec. 401(a) of the Stafford Act for all 50 states. Jurisdiction for the state of emergency, which took effect January 20, 2020, provides relief and assistance to businesses – including tax relief. Businesses experiencing financial loss directly due to COVID-19, during the disaster year, may elect to accelerate those losses to the 2019 fiscal year.

 

To accelerate a loss under these relief provisions:

  • Compensation for the loss cannot come from insurance or otherwise
  • It must be by a closed and completed transaction
  • The loss must be caused by an identifiable event
  • The losses sustained must relate to the disaster event and must be sustained during the taxable year of the event

Potential losses to accelerate on the preceding year tax return, if directly attributable to COVID-19:

  • Abandonment of business deals for costs otherwise capitalized
  • Abandonment of leasehold improvements
  • Costs related to the closure of store, branch, and facility locations
  • Inventory spoilage during the government shutdown
  • Losses from the sale or exchange of property
  • Mark-to-market securities
  • Permanent retirement of fixed assets
  • Prepaid events for travel, conference space, and hotel rooms when a refund or credit is not provided
  • Prepaid expenses to fulfill a contract when the contract is canceled
  • Payments to cancel contracts, leases, or licenses
  • Worthless securities (excluding bad debts)

The election to accelerate the loss is done on an original or amended 2019 tax return. This is a temporary tax adjustment, meaning any loss accelerated into the preceding tax year will no longer offset the current year activity.

For mortgage bankers, there may be losses on hedge positions or mortgage loans held for sale on closed deals that can be taken in 2019. All losses must be the direct result of the current coronavirus pandemic.

If the disaster loss creates a Net Operating Loss (NOL) in 2019, the taxpayer may have the added benefit of carrying back the NOL up to 5 years.

If you would like to discuss your filing options under the disaster relief provisions related to COVID-19, please contact your Spiegel tax manager.

Download the document.

Financial Statement Reporting for Proceeds from PPP Loans

History of the Paycheck Protection Program

The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided an estimated $2.2 trillion to fight the COVID-19 pandemic and stimulate the US economy, including $349 billion that was earmarked for the Paycheck Protection Program (PPP) to be administered by the U.S. Small Business Administration (SBA). An additional $310 billion was later authorized for the PPP.

Under the PPP, eligible businesses can apply to an SBA-approved lender for a loan that does not require collateral or personal guarantees. The loans have a 1% fixed interest rate and are due in two years. However, these loans are eligible for forgiveness (in full or in part, including any accrued interest) under certain conditions. For loans (or parts of loans) that are forgiven, the lender will collect the forgiven amount from the U.S. government. A recent bill has extended the repayment term to five years for any portion of the loan not forgiven.

Businesses, including mortgage bankers, must meet certain eligibility requirements to receive PPP loans and are required to meet PPP guidelines to receive loan forgiveness. Therefore, it is vital to maintain detailed documentation of the initially submitted eligibility criteria, submitted by management, as well as detailed PPP loan expenditure documentation to support payroll expenses and other eligible expenses used for loan forgiveness.

Loan forgiveness applications are subject to audit by the U.S. government with a 6-year statute; however, businesses that borrow less than $2 million are expected to receive an automatic “good faith” certification, which may mean these businesses will not be subject to an audit. Future scrutiny of the good faith certification will depend on additional guidance issued by the SBA.

Businesses that received a loan over $2 million will be subject to greater scrutiny, audit, and may be deemed ineligible. The SBA may request repayment if it is determined required expenditure guidelines were not met and more importantly, the business entity did not actually qualify for a PPP loan.

Authorized Use of Loan Proceeds

A bill passed June 5, 2020 has extended the forgiveness period from 8 weeks to 24 weeks, lowered the percentage spent on payroll costs from 75% to 60% with the remainder allotted for rent, utilities, and interest payments. This new legislation contained the stipulation that if a minimum of 60% is not used for payroll costs, no amount of the loan can be forgiven. However, following the bill’s passage, the U.S. Treasury and SBA released a joint statement clarifying that borrowers who fail to meet the 60% threshold would qualify for partial loan forgiveness. You can choose which accounting rule to apply with respect to the PPP loan. Costs are defined below:

“Payroll Costs” – This is a key term for PPP loans and includes virtually all compensation paid to employees, as salaries, commissions, or similar compensation, including tips, vacation pay, family/parental leave and sick leave. Total compensation is capped at $100,000 per year for any person, and does not include payroll taxes imposed on the employer or withheld from the employee, plus:

  • Any state or local taxes assessed on the compensation of employees paid by the employer
  • Severance pay (allowance for dismissal or separation)
  • Costs related to the continuation of group health benefits and any retirement benefits (presumably including all COBRA benefits) Payments of interest on any pre-existing debt or mortgage obligation (but not  payment or prepayment of principal on such obligations)
  • Rent (including rent under an equipment or other lease), and
  • Utilities.

Eligibility for Loan Forgiveness

PPP loan recipients must certify, in good faith, that the loan was required to continue operations due to the current economic circumstances and acknowledge that the funds have been used to retain workers and maintain payroll or make business interest, rental or lease and utility payments, and that the applicant does not have other “covered loan” applications pending for similar or duplicative purposes.

 Alternative Accounting Treatment for PPP Loan Proceeds

Under the Financial Accounting Standards Board, Accounting Standards Codification (ASC) 470, Debt, a PPP loan is considered debt, regardless of whether the borrower expects the loan to be forgiven. Alternatively, the borrower may choose to consider the loan as a government grant and amortize the funds as they are used and there is a reasonable possibility of the loan being forgiven.

A Closer Look: Accounting for the PPP Loan as Debt

Under ASC 470, a business entity would record the full amount of the PPP loan as a liability and accrue interest over the term of the loan until the loan is forgiven. Considerations: This model would be more prudent for an entity that determines there is a reasonable possibility of not meeting the necessary criteria for loan forgiveness, or the business entity determines that maintaining the debt for financial statement reporting purposes does not impact debt eporting requirements or other financial metrics.

For income statement purposes, any PPP forgiveness would be considered gain on extinguishment of debt. For cash flow statement purposes, PPP loan proceeds would be considered a financing cash inflow; repayments would be considered a financing cash outflows; and forgiven amounts would be a noncash financing activity.

Accounting for the PPP Loan as a Government Grant

The current CARES Act/PPP framework provides clear guidance on the eligible uses of the PPP loan. Businesses that have high degree of confidence in their ability to qualify for loan forgiveness, and believe they have or will meet the authorized expenditure requirements are able to amortize the loan to income as expenses are accrued or paid. While there are no clear U.S. generally accepted accounting principles (U.S. GAAP), references related to this type of government loan provided to for-profit entities, an analogy could be made to ASC 958, Not-for-Profit Entities, Conditional Contribution or ASC 450, Contingencies, Gain Contingencies.  While not U.S. GAAP, International Accounting Standard (IAS) 20, Accounting for Government Grants and Disclosure, provides a model to account for and forgive government loans. Under this model, the PPP loan would be accounted for as a grant, and a deferred liability established when funds are received. The deferred liability would be recognized in earnings in accordance with the requirements of the authorized PPP expenditures. Considerations: If this accounting treatment is elected, the business entity will have to continually assess whether it continues to meet the eligibility criteria. The SBA has also stated that it will provide further guidance and clarification regarding acceptable PPP expenditures.

For income statement purposes, the amortization of the grant would be reflected as other income, or a reduction of the expense to which it pertains.

For cash flow statement purposes, loan proceeds could be considered operating cash inflows because of nature of the expenses for which the loan is intended (e.g., payroll, rent). However, loan proceeds from financing activities may also be acceptable.

Disclosures

For either accounting treatment, the business should disclose the nature of the PPP, including the funds received, the amount deferred, the recognition of deferred amounts, and the requirements to recognize the deferred amounts as income.

Download the Spiegel document.

PPP Loan Forgiveness Application

Treasury, SBA Release Loan Forgiveness Application

The US Treasury and the Small Business Administration (SBA) have coordinated to release the Paycheck Protection Program (PPP) Loan Forgiveness Application. The PPP was enacted under the CARES Act to provide eligible small businesses with loans during the COVID-19 pandemic. The application and corresponding instructions advise borrowers on how to apply for forgiveness of PPP loans under the CARES Act.

The SBA is expected to issue regulations and guidance to assist borrowers as they complete their applications, according to the Treasury. Spiegel has been providing guidance to its clients as they work to navigate their way through the application process. It is important to provide the correct information, regarding the business loan, to ensure loan forgiveness.

Measures intended to reduce compliance burdens and simplify the process for borrowers include:

  • options to calculate payroll costs using an “alternative payroll covered period” that aligns with borrowers’ regular payroll cycles;
  • flexibility to include eligible payroll and non-payroll expenses paid or incurred during the eight-week period after receiving their PPP loan;
  • step-by-step instructions on how to perform the calculations required by the CARES Act to confirm eligibility for loan forgiveness;
  • borrower-friendly implementation of statutory exemptions from loan forgiveness reduction based on rehiring by June 30; and
  • the addition of a new exemption from the loan forgiveness reduction for borrowers who have made a good-faith, written offer to rehire workers that was declined.

Reach out to Spiegel directly if you would like assistance with the application (below).

SBA Paycheck Protection Program Loan Forgiveness Application; Treasury Press Release, May 15, 2020