Employee Retention Credit

The recently signed stimulus package included considerable enhancements to the Employee Retention Credit (ERC). The new law, known as the Consolidated Appropriations Act (CAA) expands the ERC under the CARES Act that went into effect January 1, 2021, with the covered wage period extended until June 20, 2021. The new legislation is also retroactive to wages paid after March 12, 2020; so, employers who took Paycheck Protection Program (PPP) loans in 2020 are now eligible to take the ERC, provided these wages are not used for both the credit and PPP loan forgiveness.

 Tax Changes Under CAA 2021

The good news for employers who continued to pay their employees, despite being forced to close their business either fully or partially by a COVID-19 lockdown, is they are now eligible for an ERC refund.

Period of availability: For qualified wages paid after March 12, 2020, and before July 1, 2021, extending availability of the credit to the first two quarters of 2021. These periods may be outside the covered period for many PPP loan borrowers, and the employee retention tax credit is likely available.

Credit amount: The credit amount increased from 50% to 70% of qualified wages, for 2021, which is amended to include the cost to continue providing health benefits.

Maximum credit amount: The credit cap is increased to $7,000 for each of the first two quarters of 2021 ($10,000 in qualified wages X 70% tax credit rate), so that the maximum credit for 2021 will be $14,000. This aggregate $14,000 per employee maximum credit for the first two quarters of 2021 is available even if the employer received the $5,000 maximum credit for wages paid to such employee in 2020.

Credit eligibility requirements: The applicable number of employees increased from 100 to 500. This allows employers who had 500 or fewer full-time in 2019 to be eligible for the credit, even if employees are working, provided they meet other requirements. Note that in calculating this 500-employee threshold, the employees of all affiliated companies sharing more the 50% common ownership are aggregated.

Effective January 1, 2021, business operations that are either fully or partially suspended by a COVID-19 lockdown order, or for a quarter in 2021, if gross receipts are less than 80% of gross receipts for the same quarter in 2019. This differs from the original law in 2020 that stipulated gross receipts of less than 50% qualified.

Because the ERC credit can apply to wages already paid after March 12, 2020, many struggling employers can access this credit by reducing upcoming deposits or requesting an advance credit on Form 7200, Advance of Employer Credits Due To COVID-19 (per IRS website).

Advance payment clause: Advance payment of the credit is allowed for businesses with 500 or fewer employees, based on 70% of average quarterly payroll for the same quarter in 2019. Companies may be allowed to collect the payment prior to the payment of wages. However, if the advance payment is larger than the actual credit calculated, the company will need to repay the excess.

Please contact the Spiegel team for advice and any updates on this new legislation.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Guidance for PPP 2.0

The latest stimulus bill passed by Congress allocates $284 billion to small businesses through the Paycheck Protection Program (PPP). This new legislation is said to have tighter requirements with more relaxed tax regulations. PPP round two reopens the program for first-time borrowers provides better flexibility for spending PPP funds, and, under certain conditions, allows prior loan recipients to apply for a second loan.

Who Qualifies?

For borrowers to be eligible this round, their business must have operated before February of 2020 and must have fewer than 300 employees, which is down from the previous requirement of 500. Qualified borrowers will have loans capped at $2 million, which is down from the $10 million cap in the first round. The lending guidelines for requested funds still have the amount set at 2.5 times monthly payroll, with restaurants and hotels allowed to request 3.5 times their average monthly payroll. Designed to support employees and prevent layoffs, this new bill requires 60% of the loan be used for salaries.

The first round of PPP loans established the covered period for the borrower, depending on when they received their loans. PPP 2.0 allows borrowers to choose between an 8-week or 24-week covered period. This slight change offers borrowers more control over the handling of potential workforce reductions once the PPP funds are depleted.

Chance for Second Loan?

 A recent study by the National Federation of Independent Business (NFIB) reported one-in-four small business owners reported they will soon be closing their doors if current economic conditions do not improve. The NFIB also stated that the majority of PPP borrowers (91%) have spent all their loan funds. Fortunately, these business owners may apply for a second loan also known as a “second draw.” To qualify, these borrowers must have depleted their first round of PPP and show a 25% reduction in revenue in at least one quarter of 2020 compared to the same in 2019.

Eligibility for Non-profits

Stimulus round two made provisions for 501(c)(6) not-for-profit organizations eligibility for PPP loans. These previously forgotten non-profits are often professional organizations, such as chambers of commerce, boards of trade, small business associations, tourism and hospitality coalitions, and social welfare groups. Such organizations can apply for PPP provided they do not receive more than 15 percent of their revenue from lobbying activities and have fewer than 300 employees.

 Spending Allowances & Tax Breaks

 PPP 2.0 allows for funds to be spent on business expenditures other than wages and rent, unlike the first pass. Borrowers are permitted to pay for supplies, software, accounting expenses, and personal protection equipment. Also covered are costs related to property damage or vandalism, which occurred in 2020, due to looting or public disturbances that were not covered by insurance.

Similar to prior legislation, PPP funds will be tax-exempt. Furthermore, the new legislation also stipulates that expenses paid with proceeds of a PPP loan that is forgiven to be considered tax-deductible. This applies to both new and existing former PPP loans. This reverses IRS and Treasury guidance issued this past November that declared borrowers could not deduct PPP expenses if the loan had been forgiven.

 Loan Forgiveness

 Revisions to the new PPP legislation creates a more streamlined loan forgiveness process. Borrowers who receive no more than $150,000 are now offered a simple one-page application. Round one offered this process for loans up to $50k. The simplified form requires borrowers to provide a description of the number of employees the business was able to retain due to the PPP loan, along with an estimate of the total amount of PPP proceeds spent on payroll costs. Borrowers who choose to submit this simplified application should carefully check their calculations and responses due to penalties for producing false statements. It would be prudent to consult with an accounting advisor, especially considering such expenses are now tax-deductible under the new bill.

 How to Get a PPP Loan

 In an effort to address previous criticism of the PPP initiative, minority-owned or economically disadvantaged businesses will be offered the first crack at PPP loans on Monday, January 11, 2021. The SBA is seeking to ensure that small, vulnerable businesses can access this new round of money before larger businesses claim the funds as happened in the first PPP offering. So-called community financial institutions will have access to the $60 billion set aside for businesses that had been previously shut out, with an emphasis on those with 10 or fewer employees or those in low-income areas.

The second round of loan applications is scheduled to begin on January 13th with the deadline to apply on March 31st.  However, keep in mind, applications will no longer be received once the initial second round of funds is depleted.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

IRS Changes to Schedule K-1

The Internal Revenue Service (IRS) made significant changes to the Schedule K-1 for the 2020 tax year to improve the quality of information reported by partnerships. This consists of modified instructions for partnerships required to report capital accounts to partners. All partnerships, including limited liability companies taxed as partnerships, are required to report partners’ capital in Box L on the Schedule K-1.

Prior to 2020, a partnership could report partners’ capital using one of the following methods: tax basis, GAAP basis, Section 704(b) basis, or other method. With Notice 2020-43, all partnerships, including limited liability companies taxed as partnerships, are required to report partners’ capital on a tax basis starting with the 2020 tax return. Notice 2020-43 outlines two methods of reporting tax basis capital: Modified Outside Basis Method and Modified Previously Taxed Capital Method. The preliminary instructions for the 2020 Form 1065 provide a third option under consideration: Transactional Approach.

Modified outside basis method. The amount to report as a partner’s beginning capital account under the modified outside basis method is equal to the partner’s adjusted tax basis in its partnership interest as determined under the principles and provisions of subchapter K including, for 1) the partner’s share of partnership liabilities under section 752 and (2) the sum of partner’s section 743(b) adjustments. For purposes of establishing a partner’s beginning capital account, you may rely on the adjusted tax basis information provided by your partners. .

Modified previously taxed capital method. The amount to report as a partner’s beginning capital account under the modified previously taxed capital method is equal to the following: The amount of cash the partner would receive if you liquidated after selling all of the assets in a fully taxable transaction for cash equal to the fair market value of the assets; increased by the amount of tax loss determined without taking into account any section 743(b) basis adjustments that would be allocated to the partner following such a liquidation; and decreased by the amount of tax gain determined without taking into account any section 743(b) basis that would be allocated to the partner following such a liquidation. Instead of using the assets’ fair market value, you may determine the partnership’s net liquidity value, and gain or loss, by using such assets’ bases as determined under section 704(b), as determined for financial accounting purposes, or on the basis set forth in the partnership agreement for purposes of determining what each partner would receive if the partnership were to liquidate, as determined by partnership management.

Transactional approach. The amount to report as a partner’s beginning capital account under the transactional approach is (1) increased by the amount of cash and the tax basis of property contributed by the partner to the partnership (less liabilities assumed by the partnership or to which property is subject) as well as allocations of income or gain made by the partnership to the partner, and (2) decreased by the amount of cash and the tax basis of property distributed by the partnership to the partner (less any liabilities assumed by the partner or to which the property is subject) as well as allocations of loss or deduction made by the partnership to the partner.

The partnership is required to use one of the methods, and the method selected must be used by all partners for the year. While the capital on the K-1 may look different for 2020, the change to tax basis reporting does not cause an economic consequence to the partner. This is strictly a reporting requirement. However, partnerships that do not comply with the new reporting requirements will be subject to late filing penalties for failure to show all required information. For 2020, the late filing penalty is $210 for each month or part of a month, for a maximum of 12 months, multiplied by the total number of persons who were partners in the partnership during any part of the partnership’s tax year.

Check your 2019 K-1 statement to determine the prior method for basis reporting. Many partnerships will opt for the modified previously taxed capital method due to the availability of information. Please contact your Spiegel team with any questions or to discuss your options.

 

Author, Peter Lloyd

Senior Tax Manager, Spiegel Accountancy Corp

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

2020 COVID-19 Tax Credits for the Workplace

Tax credits for paid sick and family leave

The Families First Coronavirus Response Act (FFCRA) provides two self-employed tax credits to help cover the cost of taking time off due to COVID-19. While most of the text in these laws apply to businesses with employees, it also applies to self-employed individuals.

The tax credit for paid sick leave applies to eligible self-employed taxpayers who are unable to work (including telework or working remotely) due to:

  • Being subject to a federal, state, or local quarantine or isolation order due to COVID-19.
  • Being advised by a health care provider to self-quarantine due to COVID-19. Experiencing COVID-19-related symptoms and seeking a medical diagnosis. If you meet all the requirements, you would be eligible for qualified sick leave for each day during the year that you were unable to work for the above reasons (up to 10 days). The tax credit is worth the lesser of $511 per day or 100% of your average daily self-employment income for the year per day.
  • The only days that may be considered in determining the qualified sick leave equivalent amount are days occurring during the period beginning on April 1, 2020 and ending on December 31, 2020.

Under the expanded Family and Medical Leave Act (FMLA) provision of the FFCRA, you would be eligible for qualified family leave for each day that you were unable to work because you were caring for someone else impacted by COVID-19 (up to 10 days), or your child’s school or childcare provider was closed or unavailable due to COVID-19 (up to 50 days). You can claim a tax credit for the lesser of $200 per day or 67% of your average daily self-employment income for the year per day.

 How do I calculate and claim these tax credits?

The “average daily self-employment income” is calculated as your net earnings from self-employment during the tax year, divided by 260. An individual can claim a credit for both qualified sick leave and qualified family leave, but not both for the same time periods. You can claim both the tax credit for paid sick leave and the tax credit for paid family leave on your 2020 Form 1040 tax return. However, you do not have to wait until the next tax-filing season to benefit from these credits

 Employee Retention Credit

 If you have employees, the Employee Retention Credit (ERC) can help you cover the cost of keeping idle workers on your payroll during the pandemic. The tax credit is worth half of what you spent on wages and employee health plan costs after March 12, 2020, and before January 1, 2021, up to $10,000 per worker.

To qualify, your business must have one of the following:

  • A full or partial suspension of its operations due to governmental orders limiting commerce, travel, or group meetings due to COVID-19.
  • A sufficient decline in gross receipts compared to 2019. The decline begins when there is a 50% drop in a calendar quarter compared to the same quarter in the prior year. The decline does not end until a calendar quarter reaches 80% of the same prior-year quarter. This means that if a quarter drops to less than 50% and the following quarter is at 70%, there is still a decline.

You can claim this credit by reducing your payroll tax deposits. If your employment tax deposits are not enough to cover the full credit, you can get an advance from the IRS by filing Form 7200.

If you received a Paycheck Protection Program loan, you cannot also claim the ERC. You can claim both the paid leave credits and the ERC but not on the same wages.

For more information, contact your tax advisor and/or visit the U.S. Department of Labor website: https://www.dol.gov/agencies/whd/pandemic/ffcra-employer-paid-leave

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

The 12-Month Rule – Determining the Deductibility of Prepaid Expenses

Taxpayers seeking additional business deductions before the end of the year might consider adopting the 12-month rule by prepaying some business expenditures before year-end. Certain expenses such as insurance, rebates, and licenses can be prepaid before year-end without needing to be capitalized for tax purposes, thus allowing a tax deduction for the current tax year. The 12-month rule must satisfy the requirements of economic performance in order to be utilized. The recurring item exception may provide some relief if the economic performance standard isn’t met.

Basics of the 12-Month Rule

Under normal circumstances, IRS regulations require taxpayers to capitalize (i.e., not deduct) amounts paid for certain prepaid assets. In other words, let’s say you spend $1,000 of your hard-earned money in October on a license that lasts one year. This doesn’t necessarily mean the entire amount is deductible in the tax year the payment is made. Cash-out = tax deduction. Those more familiar with accounting principles will argue that the matching principle needs to be applied, meaning that the deduction should be applied to the period in which it provides a benefit. Meaning, you would deduct 3/12 of the expense in the year the payment is made and 9/12 in the following year. This would be the IRS’ approach (See Reg. Sec. 1.162-3(d)). Taxpayers may be allowed to deduct the full $1,000 amount in the year in which it was paid by applying the 12-month rule. To apply this rule, we must look to Reg. Sec. 1.263(a)-4(f) which states that:

Except as otherwise provided in this paragraph, a taxpayer is not required to capitalize amounts paid to create any right or benefit for the taxpayer that does not extend beyond the earlier of:

  • 12 months after the first date on which the taxpayer realizes the right or benefit; or
  • The end of the taxable year following the taxable year in which the payment is made.

Let’s apply this to our license example. A license that lasts one year was purchased in October of the current year and it is set to expire in September of the following year. The payment creates a right that does not extend 12 months after it is initially created, thus satisfying the first condition. Also, it does not extend past the following taxable year since it ends in September, which satisfies the second condition. If the right had extended beyond September of the following year, the 12-month rule would no longer be satisfied, and the license would need to be deducted ratably over the life of the license.

Exception to the Exception: Understanding Economic Performance

The 12-month rule cannot be universally applied in all situations. If another regulation or code section specifically states that a certain type of prepaid asset is disallowed, the 12-month rule will not apply. Cash basis taxpayers will have slightly different results from accrual basis taxpayers. The rules for cash-basis taxpayers are relatively straight-forward: make the payment, and as long as the conditions above for the 12-month rule are satisfied, the taxpayer is eligible for the deduction. However, in order for this to always be true, economic performance must be satisfied. This is also true for accrual-basis taxpayers, but unlike cash basis taxpayers, accrual basis taxpayers will accrue certain expenses at year-end that a cash basis taxpayer will not.

In basic terms, economic performance is the timing of when a liability owed by a taxpayer is truly treated as being incurred. All of the necessary events need to have happened to determine that a) a liability is fixed, b) the amount can be determined with reasonable accuracy, and c) a specific action or event has taken place. For example, economic performance occurs for the following liabilities:

  • Rent Expense – generally, ratably over the period the taxpayer is entitled to use the property
  • Services – occurs as services are provided
  • Insurance – occurs when payment is made

This means that for prepaid services and prepaid rent, economic performance isn’t satisfied until the property is used or until the service is provided to the taxpayer, respectively. As such, merely paying the liability doesn’t mean the payment can be deducted. However, payment for an insurance premium in the event that needs to take place for economic performance. Assuming the 12-month rule is satisfied, prepaid insurance will be deductible upon payment. A more comprehensive list of prepaid assets and their respective economic performance traits can be found at the end of the article.

Exception to the Exception to the Exception: The Recurring Item Exception

What happens if economic performance hasn’t occurred, but you really want that tax deduction? It’s at the top of your wish list and you’ve been good all year. Surely Santa will step in on your behalf. Well, congratulations! The recurring item exception exists! Reg. Sec. 1.461-5 states that economic performance will be treated as having occurred with respect to liability if:

  1.  The liability is recurring in nature and is either not material, or provides for better matching of income and expense,
  2.  And economic performance will occur before the earlier of 8 1/2 months after year-end, or the filing of the tax return.

For example, a taxpayer accrues an expense for an insurance premium year-end. The premium covers October of the current year to September of the following year. The taxpayer makes the payment on January 15th of the following year. Even though this satisfies the 12-month rule, economic performance has not occurred before year-end since payment has not been made. However, under the recurring item exception, the deduction may be taken since insurance premiums are recurring in nature. It is not material, and payment was made within 8 ½ months of year-end.

Note: The recurring item exception cannot be applied to interest, rents, worker’s compensation, tort, breach of contract, and violation of law.

Bringing It All Together

To see how all of these concepts work together, let’s go through two examples:

Example 1:  Prepaid Advertising

On December 15th, a taxpayer pays a marketing firm $10,000 for advertising services that the taxpayer believes will be performed over the next 3 months. The marketing firm completes the advertising service by February 28th of the following year.

  • 12-Month Rule – The conditions for the 12-month rule are satisfied because the benefit to the taxpayer is realized within 12 months of the payment.
  • Economic Performance – For services, economic performance is satisfied as services are provided. The amount of the liability is fixed and determinable at year-end. However, the services were not provided by the end of the year so economic performance is not satisfied. Economic performance rules trump the 12-month rule, so it’s not looking good for the taxpayer thus far.
  • Recurring Item Exception – The taxpayer argues that they regularly engage marketing firms and the amount paid is not material to their financial statements. Also, the payment was made before filing the tax return.
  • Conclusion – The recurring item exception allows the taxpayer to apply the 12-month rule and the taxpayer is able to take the deduction. Note that for prepaid services, services must be provided within 3 ½ months of the payment being made. Other prepaids, such as prepaid interest, can be paid within 8 ½ months of year-end and still be deductible.

Example 2:  Prepaid Interest

On December 15th, a taxpayer pays an interest obligation of $10,000 related to business debt covering the second half of December and the first half of January of the following year.

  • 12-month Rule – The conditions for the 12-month rule are satisfied because the benefit to the taxpayer is realized within 12 months of the payment.
  • Economic Performance – For interest, economic performance is satisfied as the borrower has use of the money. The amount of the liability is fixed and determinable at year-end. However, the taxpayer cannot “use” the money for January in December, so economic performance is not satisfied. Again, economic performance rules trump the 12-month rule; so, it is still nondeductible.
  • Recurring Item Exception – The taxpayer argues that they regularly pay interest and the amount paid is not material to their financial statements. Also, the payment was made before filing the tax return. However, prepaid interest is one of the exclusively carved out items that cannot be applied by the recurring item exception.
  • Conclusion – Even though the 12-month rule is satisfied, economic performance and the inability to apply the recurring item exception prevent the taxpayer from deducting the prepaid January interest.

As you can see, these concepts work together to provide some relief to taxpayers while still trying to prevent abuse by others who would seek to make large prepayments before year-end for the sole purpose of lowering their tax liability. When determining the deductibility of prepayments for tax purposes, every situation is unique and requires a fair bit of analysis and understanding to make sure the taxpayer takes a defensible position. One should always consult with their tax advisor on their own circumstances to determine best practices.

Prepaid Expenses and Economic Performance

Prepaid Expense Economic Performance
Prepaid Insurance Payment

 

Prepaid Warranty and Service Contracts Payment

 

Prepaid License or Permit Fees Payment

 

Prepaid Taxes Payment

 

Prepaid Dues and Fees Payment

 

Prepaid Rebates Payment

 

Prepaid Rent Ratably over the period of time the taxpayer is entitled to use the property

 

Prepaid Services As services are performed

 

Prepaid Interest Ratably as the taxpayer has use of the money being borrowed

 

Prepaid Goods As the goods are provided to the taxpayer

 

Author, Jonathan Smith, Senior Tax Manager, Spiegel Accountancy Corp

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Paycheck Protection Program Tax Treatment

More than 500 like-minded stakeholders are calling on Congress to overturn an Internal Revenue Service rule and allow Paycheck Protection Program (PPP) loan forgiveness to be fully tax-free.

In a December 3, 2020 letter to leaders of the House and Senate, the groups, led by the Associated General Contractors of America, urged lawmakers to enact legislation before the end of the year to correct the tax treatment of loan forgiveness under PPP.

IRS Notice 2020-32 states that “normally deductible business expenses will not be deductible if the business pays the expense with a Paycheck Protection Program loan that is subsequently forgiven,” which the coalition believes is a misinterpretation of the Coronavirus Aid, Relief and Economic Security Act. Section 1106(i) of the CARES Act states business expenses are “includible in gross income of the eligible recipient by reason of forgiveness” and “shall be excluded from gross income,” for purposes of the Internal Revenue Code of 1986. The coalition wants Congress to clarify this contradiction.

“At the onset of the COVID-19 pandemic, Congress responded with speed, cooperation, and an eye to preventing the worst potential economic outcomes. We ask that you bring that same spirit of urgency and cooperation before the end of this session to prevent an avoidable catastrophe for millions of small businesses that, without Congressional action, will face a surprising, and, in many cases, insurmountable tax bill next year,” the groups wrote. Spiegel Accountancy Corp Founding Principal, Jeff Spiegel, says, “Congress needs to act to get this resolved to allow expenses to be deducted.”

“The terms of the PPP are simple: if qualifying small businesses use a federally-guaranteed loan to pay their employees and cover certain non-payroll expenses, the loan will be forgiven,” the letter continued. “From April 3rd, when the program launched, through August 8th, when its authorization expired, the Small Business Administration guaranteed $525 billion in PPP loans to 5.2 million qualifying small businesses nationwide, preserving tens of millions of paychecks for their employees as the pandemic spread throughout the country.”

The coalition noted that if unchanged, the IRS ruling could increase small businesses’ taxes up to 37%.

“Since the IRS issued Notice 2020-32, Congress has signaled that it intends to reverse the ruling,” the letter said. “The Democratic and Republican Chairs of the House Ways and Means and Senate Finance Committees issued public statements saying that the IRS Notice, and, more recently, the IRS Revenue Ruling, is flawed and contrary to Congressional intent.”

The coalition added that the “most recent IRS revenue ruling” has created a renewed sense of urgency for Congress to address the issue before the end of the year.

“Allowing the IRS position to remain unchallenged will result in a significant tax increase on small business owners already suffering from the effects of COVID-19 shutdowns,” the groups wrote. “This tax will hit small business owners after their PPP loan has already been spent, and just as many states are re-imposing mandatory closures of thousands of businesses in the face of spiking numbers of COVID-19 cases. Many PPP loan recipients retained employees on their payrolls, even when there was little to no work to perform, in compliance with the intent of the program to keep people employed and off the unemployment rolls. The IRS changed the rules after businesses took out PPP loans, and business owners are now being asked to pay what amounts to a surtax on their workforce.

“Without Congressional action, businesses will face an unexpected tax bill when they file their taxes for 2020, as they continue to struggle with government-mandated shutdowns or slowdowns. Many of those businesses will close and never re-open. This senseless tax policy stands both the letter and spirit of the PPP on its head,” the letter concluded.

 

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Time to Apply for PPP Loan Forgiveness?

The 24-week period for many of the original Paycheck Protection Program (PPP) loans ended during the month of November. Those who elected for an 8-week program, or have exhausted their funds, may have begun the process of applying for forgiveness even though there is plenty of time left. Fortunately, the application process for loan forgiveness has operated much more smoothly than the original loan application period.

PPP loans were created to incentivize small businesses to retain employees by helping cover payroll costs as many businesses were forced to shutter during the COVID-19 lockdown. These loans also covered mortgage interest payments or rent, along with utilities to help businesses stay afloat. Treasury Secretary Steve Mnuchin stated, “The PPP has provided 5.2 million loans worth $525 billion to American small businesses, providing critical economic relief and supporting more than 51 million jobs.

PPP Loan Forgiveness Application Deadlines

 While borrowers who received their loan prior to June 5, 2020 could have elected for an 8-week or 24-week covered period, loans funded on or after June 5th meant waiting until November (or later) to apply for forgiveness. Keep in mind that loan payments may be deferred for up to 10 months following the end of the established loan period. It is also important to note the covered period begins the day the loan was funded.

In October, the Small Business Administration (SBA) released a new loan forgiveness application, making it easier for those with PPP loans of $50,000 or less. Banks have begun the initial phase of accepting these PPP applications from borrowers even though the time to apply depends on the bank and when the PPP covered period ends. For example, Bank of America will not take submissions until the covered period ends, while other banks will accept applications after the PPP funds have been exhausted. Most banks encourage borrowers to prepare the application for loan forgiveness immediately following the end of the loan period and collect the necessary documentation in preparation. The SBA has provided a fillable questionnaire to assist the application process.

According to the SBA, there are an estimated 3.57 million outstanding PPP loans of $50,000 or less, totaling approximately $62 billion of the $525 billion in PPP loans. The SBA suggests borrowers contact their PPP lender to obtain the correct form. They will provide either the SBA Form 3508, SBA Form 3508EZ, SBA Form 3508S, or a lender equivalent. The expiration date listed on the application forms has created some confusion. Essentially, it is a temporary date required by the SBA’s Paperwork Reduction Act, and each month a new expiration date is placed on the forms.

Borrowers may apply for forgiveness any time before the maturity date of the loan, which may be two to five years from loan origination. However, applying after the 10-month deferment means a borrower must begin making payments on the loan. While the SBA has 90 days to review and approve the applications, lenders have seen a much faster turnaround time.

PPP Loan Integrity

Businesses holding loans that exceed the $50,000 threshold require additional documentation to apply. Borrowers are encouraged to maintain close contact with their lenders as each may have developed its own evaluation and process procedures in addition to those required by the SBA. Businesses that received $2 million or more in PPP loans must complete one of two required loan necessity questionnaires, SBA Form 3509 and SBA Form 3510. The SBA recently offered additional guidance on these sizable loans. (See Rev. Rul. 2020-27 on PPP Loans and Taxes)

The U.S. Treasury maintains that all loans above the $2 million mark will be subjected to additional scrutiny under the current audit plan. Additionally, the Department of Justice established a fraud team as soon as PPP loan applications became available. Any amount of fraud has been strongly discouraged. It is important for borrowers to consult with their tax accountant, in addition to their lender, to ensure the application process completed accurately.

For more information on the Paycheck Protection Program, visit the SBA website.

 

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Rev. Rul. 2020-27 on PPP Loans and Taxes

On November 18, 2020, the U.S. Treasury Department and the Small Business Association (SBA) released Rev. Rul. 2020-27 that offers additional guidance on the tax treatment of expenses paid using Paycheck Protection Program (PPP) funds in the event the loan is not forgiven by the end of 2020. The IRS ruling concerning deductions for eligible PPP loan expenses is as follows:

(1) deny a deduction if the taxpayer has not yet applied for PPP loan forgiveness, but expects the loan to be forgiven; and

(2) provide a safe harbor for deducting expenses if PPP loan forgiveness is denied or the taxpayer does not apply for forgiveness.

The Treasury press release stated, “Since businesses are not taxed on the proceeds of a forgiven PPP loan, the expenses are not deductible. This results in neither a tax benefit nor tax harm since the taxpayer has not paid anything out of pocket.” Secretary Steve Mnuchin said, “These provisions ensure that all small businesses receiving PPP loans are treated fairly, and we continue to encourage borrowers to file for loan forgiveness as quickly as possible.”

While debt cancellation is ordinarily considered to be income, the PPP loan amount is nontaxable income. Borrowers may not deduct expenses paid with PPP funds (i.e. rent, mortgage interest, utilities) as that would be double-dipping. One of the most common questions is what if a borrower does not deduct expenses that ultimately end up not approved through loan forgiveness. Answer: It is possible to file an extension on 2020 taxes or file an amended income tax return once loan approval (or partial) has been authorized.

Additionally, the Treasury and IRS released Rev. Proc. 2020-51 this same day. This ruling provides a safe harbor for certain PPP loan participants, whose loan forgiveness has been partially or fully denied, or who decide to relinquish loan forgiveness, to claim a deduction for certain otherwise deductible eligible payments during the 2020 tax year.

Safe Harbor rules allow borrowers who decline loan forgiveness to claim a deduction for the otherwise deductible eligible payments on an original income tax return or information return, as applicable, for the taxable year in which the taxpayer decides to forego requesting forgiveness.

Mnuchin added, “Today’s guidance provides taxpayers with greater clarity and flexibility.”

 

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

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.

 

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

What You Need to Know About the Centralized Partnership Audit Regime

What You Need to Know About the Centralized Partnership Audit Regime was originally published in AAPL’s Winter 2019 Edition of Private Lender Magazine.

Fund managers may not be aware of their new role during an IRS audit of companies with partnered members. The new centralized partnership audit regime (CPAR) introduced by the Bipartisan Budget Act (BBA) started with the 2018 tax year.

Under the old rules, there was no mechanism for the IRS to collect tax at the partnership level when issuing an IRS audit adjustment. Instead, the IRS had to seek payment of underpaid tax directly from partnership members. The old rules left the IRS with the inability to effectively collect tax from partnerships that have dozens, or even hundreds, of minority members.

The CPAR resolves the issue by allowing the IRS to collect tax directly from a partnership and shifts the responsibility for the collection of tax to the partnership.

Under Sec. 6221(b), certain partnerships are eligible to elect out of the BBA annually. If electing out, the IRS would generally make any adjustment relating to the partnership’s return in an audit of a partner, not an examination of the partnership. The partnership would not owe any taxes, interest or penalties.

A partnership can elect out of the CPAR if the partnership meets specific eligibility requirements. A partnership  is eligible within a tax year if it has 100 or fewer eligible partners. Eligible partners are individuals, C corporations, S corporations, foreign entities that would be C corporations if they were domestic entities, and estates of deceased partners.

A partnership is not eligible if it is required to issue a Schedule K-1 to any of the following partners:

  • Other partnerships
  • Disregarded entities
  • Trusts
  • An estate of an individual other than a deceased partner
  • Any person who holds an interest in the partnership on behalf of another person
  • Foreign entities that would not be treated as a C corporation were it a domestic entity

With these restrictions, fund managers will often find that their fund does not meet the eligibility requirements to elect out of the CPAR based on the composition of the fund’s investors.

Role of the Partnership Representative

Section 6223 of the code provides that unless the partnership has made a valid election out of the CPAR, each partnership must designate a partner or other person with a substantial presence in the U.S. as the partnership representative who shall have the sole authority to act on behalf of the partnership.

If an entity is designated as a partnership representative, the partnership must also appoint an individual to act on the entity’s behalf (a designated individual). To be a designated individual, the appointed person must also have a substantial presence in the U.S.

The partnership representative (or designated individual) can be the fund manager or any other individual, such as a CFO or controller. With the CPAR allowing the IRS to make tax assessments and collections of tax, interest and penalties at the partnership level, there are a few issues for fund managers and partnership representatives to consider:

  • Should the private placement memorandum (PPM) or LLC operating agreement be updated?
  • Can the fund withhold the tax from current year distributions, and what effect would that have on the fund’s yield?
  • Will a prior-year tax liability be shouldered unevenly by the current investors whose composition has changed through the admittance of new investors, or can the tax be specially allocated?
  • How to plan for the collection of taxes from investors who have already redeemed their investment from the fund

LLC Operating Agreement Revisions

Fund managers should review their PPM and LLC operating agreements with their legal counsel and tax advisors. Suggested changes include, but are not limited to, the following:

  • Replacement of a “tax matters partner” with a “partnership representative”
  • A statement that under section 6223, the partnership and its members are bound by actions of the partnership representative in dealings with the IRS
  • The elections or opt-outs that the partnership representative may make
  • That the designation for a partnership tax year remains in effect until the designation terminates
  • The partnership being held responsible for remittance of additional tax rather than individual partners being taxed
  • Current partners may be held responsible for the tax liabilities of prior partners
  • A disclosure that the taxes, interest and penalties would be calculated based on the highest tax rates

Observations

The 2018 IRS Data Book published in May 2019 accounts for the number of IRS examinations in 2018 of the 2017 tax year. Out of the 195 million tax returns filed in 2018 for the 2017 tax year, only 8,945 partnerships were selected for audit. Compare that with the 892,187 of individual tax returns audited, and it is clear to see that the IRS saw little benefit in pursuing audits of nontaxable partnerships. The question arises of whether we will see the IRS increase the number of partnership examinations for 2018 and future tax years.

Conversely, IRS audit rates are dropping overall due to a shrinking IRS budget. Examinations decreased by one-third in the past five years, down to only 0.5% of all tax returns filed. This decrease is anticipated to continue to trend lower. With such a low likelihood of an IRS examination, fund managers will want to ensure that their LLC operating agreement language is up-to-date for their changing responsibility but will not need to be overly concerned about being selected for an audit.

About the Author:

Beeta Lecha is a principal at Spiegel Accountancy Corp. She leads the Taxation and Fund Accounting practices. Lecha has 13 years of private equity and alternative investments experience, primarily focusing on private lending and real estate funds. In addition to fund accounting and investor reporting, Lecha provides tax strategy, tax planning and tax compliance for fund managers and real estate investors. Lecha is a member of the American Institute of Certified Public Accountants (AICPA) and the California Society of CPAs (CALCPA). She serves on the Education Advisory Committee of the American Association of Private Lenders (AAPL).

 

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.