The Consolidated Appropriations Act, 2021 (the “Appropriations Act”), one of the longest bills ever passed in the history of the U.S. Congress, was signed into law on December 27, 2020. This legislation provides approximately $900 billion in new stimulus funding, of which $284 billion has been allocated to the Paycheck Protection Program (“PPP”). Title III of the Appropriations Act, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid Act”), makes material changes to the PPP, including a new framework where smaller businesses may be eligible for a second PPP loan.
This Alert summarizes certain material provisions of the Appropriations Act and the Economic Aid Act relative to PPP loans, including several tax related provisions that will benefit PPP borrowers. Please note that, although the U.S. Small Business Administration (“SBA”) issued guidance last week regarding certain aspects of the new PPP changes, there will be additional guidance that may have a material impact on the program. Also, sweeping legislation of this nature frequently includes inconsistencies and areas that are subject to differing interpretations.
Second Draw PPP Loans
The Economic Aid Act establishes a new second draw PPP loan (“Second Draw Loan”) for smaller, harder hit borrowers who have already received a PPP loan, up to a maximum amount of $2,000,000. Though the conditions for the Second Draw Loans are generally the same as those for the initial PPP loans (“First Draw Loans”), the eligibility criteria for Second Draw Loans are narrower in three key areas:
- The business may only have 300 or fewer employees (rather than 500), subject to certain exceptions;
- The business must have experienced a 25% reduction in gross receipts in 2020 as compared to 2019; and
- The full amount of the First Draw Loan must have been used prior to disbursement of the Second Draw Loan.
Although the Economic Aid Act does not define “gross receipts,” SBA guidance provides that the definition of receipts will be consistent with the definition of receipts in the SBA’s size regulations. Documentation sufficient to establish the 25% reduction in gross receipts must be provided at the time of application for any Second Draw Loans greater than $150,000. For those loans less than $150,000, borrowers will be required to submit such documentation at the time such borrowers apply for loan forgiveness.
The maximum loan amount for a Second Draw Loan will be the lesser of (i) 2.5 times average monthly payroll costs, or (ii) $2,000,000. However, in the case of accommodation and food services businesses (a business entity assigned an NAICS code beginning with 72), average monthly payroll would be multiplied by 3.5, not 2.5. At least 60% of the proceeds from the Second Draw Loans must be used on eligible payroll costs, which is unchanged from the rules governing prior PPP loans—though the list of eligible costs has been expanded, as described below.
First Draw PPP Loans
Eligible borrowers that failed to obtain a PPP loan prior to the final application deadline last year (August 8, 2020) may apply for a First Draw Loan this year on largely the same terms and conditions, with certain exceptions that are outlined in the Economic Aid Act and related guidance. The maximum loan amount for First Draw Loans continues to be $10 million.
Applications will be accepted until the earlier of (i) March 31, 2021, or (ii) the date that the available funding has been exhausted. According to SBA guidance, SBA will accept applications for First Draw Loans from community financial institutions starting on January 11, 2021. Shortly thereafter, the PPP will be open to all participating lenders.
In addition to those identified in The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), eligible borrowers under the Economic Aid Act include:
- The following types of businesses with 300 or fewer employees:
- Housing cooperatives;
- 501(c)(6) organizations; and
- Destination marketing organizations.
- The following types of businesses with 500 or fewer employees per physical location:
- Businesses with an NAICS Code beginning with 72 (accommodation and food services); and
- Eligible news organizations.
Additional Eligible Expenses
Compared to the CARES Act, the Economic Aid Act expands the list of eligible expenses to include the following:
- Worker protection costs related to COVID-19, including PPE;
- Uninsured property damage costs caused by looting or vandalism during 2020;
- Certain essential supplier costs;
- Expenses for operations; and
- Certain group insurance payments.
An eligible borrower who receives a PPP loan under the Economic Aid Act will qualify for full loan forgiveness if during the “covered period” (the period beginning on the date of disbursement and ending on a date selected by an eligible borrower that is between 8 and 24 weeks after such date of disbursement) the borrower:
- Maintains employee and compensation levels; and
- Spends loan proceeds on payroll costs and other eligible expenses, provided that at least 60% of loan proceeds must be used on payroll costs.
Increased Loan Amount
The Economic Aid Act allows existing PPP borrowers that by December 27, 2020 did not receive loan forgiveness to (1) reapply for a First Draw Loan if the borrower previously returned all or some of its initial First Draw Loan; or (2) in some cases, request to modify their First Draw Loan amount if previously they did not accept the full amount for which they were eligible.
The Economic Aid Act provides that borrowers who received PPP loans in an amount no greater than $150,000, whether before or after passage of the legislation, will be able to submit a simplified, one-page loan forgiveness application, provided that such borrowers certify compliance with the applicable PPP forgiveness requirements. Such borrowers will be required to maintain certain records for a specified period and will remain subject to SBA audit. The SBA has 24 days after the enactment of the Appropriations Act to publish this new short form forgiveness application.
Applicants will still be required to make a good faith certification that “[c]urrent economic uncertainty make this loan request necessary to support the ongoing operations of the Applicant.”
The Economic Aid Act repeals the Section 1110(e)(6) of the CARES Act, which required PPP lenders to deduct from any PPP forgiveness payment the amount of any Economic Injury Disaster Loan (“EIDL”) advance received by a PPP borrower.
Clarification of Tax Treatment of Forgiveness of Covered Loans
The CARES Act had provided an exclusion from gross income for forgiveness of PPP loans. The IRS subsequently issued Notice 2020-32 applying longstanding tax authority relating to nondeductibility of expenses paid in connection with tax-exempt income to advise that expenses (payroll, rents, mortgage interest, utilities) paid with a forgiven PPP loan are not deductible. This in effect caused the forgiveness of PPP loans to become taxable, notwithstanding Congressional intent.
The Appropriations Act addresses the intended tax consequences of forgiveness of a PPP loan and reverses Notice 2020-32. The Appropriations Act again provides that gross income does not include any amount that would otherwise arise from the forgiveness of a PPP loan. It now clarifies that deductions are allowed for otherwise deductible expenses paid with the proceeds of a PPP loan that is forgiven. It further clarifies that the tax basis of the borrower’s assets and other tax attributes of the borrower will not be reduced as a result of the loan forgiveness. That prevents the amount of the loan forgiven from becoming taxable on a sale of assets or prevents increased taxes to a borrower as a result of reduced depreciation or amortization or a reduction in net operating losses. The Appropriations Act also treats the forgiven PPP loan as tax-exempt income that increases an owner’s basis in a pass-through entity such as an S corporation or partnership. That similarly prevents the forgiven loan from becoming taxable on a sale of the interest in the pass-through entity. The provision is effective as of the date of enactment of the CARES Act. The provision provides similar treatment for Second Draw PPP loans, effective for tax years ending after the date of enactment of the provision.
State and local taxes are beyond the scope of this Alert. However, borrowers should be aware that whether forgiveness of PPP loans is similarly exempt from state and local taxation will depend on the jurisdiction’s conformity with the federal tax laws.
Provisions Relating To Employee Retention Credit
The CARES Act had provided a refundable employee retention credit against the employer share of Social Security tax for 50% of qualified wages, including health care costs, paid by employers to employees from March 13, 2020 through December 31, 2020. The credit is available to employers whose (1) operations were fully or partially suspended, due to a COVID-19-related shut-down order, or (2) gross receipts declined by more than 50% when compared to the same quarter in the prior year. The credit is limited to $5,000 per employee. A business that took advantage of the PPP loan program was however ineligible to use the employee retention credit. In addition, a taxpayer that was affiliated (by more than 50% common ownership) with a taxpayer that took a PPP loan was ineligible to claim the credit.
The Appropriations Act makes the following changes to the employee retention credit:
Eligibility of PPP Borrowers for Employee Retention Credits.
Under the Appropriations Act, a borrower who receives a PPP loan is no longer prohibited from claiming the employee retention tax credit. This change also allows affiliates of PPP borrowers to claim the credit. However, the Appropriations Act provides that the credit may not be claimed for qualified wages paid with the proceeds of a PPP loan that have been forgiven – the taxpayer cannot get both the credit and PPP loan forgiveness on the same wages. Priority goes to the employee retention credit although a taxpayer may elect to not include certain wages and allocable health care costs in the computation of the credit to preserve those costs for PPP forgiveness. This change is retroactive to the effective date under the CARES Act (for wages paid after March 12, 2020).
Because the change is retroactive, presumably a taxpayer will be able to claim the credit and refunds of payroll taxes on amended payroll tax returns on Form 941X. The Appropriations Act also provides for Treasury to prescribe rules allowing taxpayers to claim the 2020 credit by treating wages paid before October 1, 2020 as wages paid in the calendar quarter in which the Appropriations Act is enacted.
Extension of Employee Retention Credit to June 30, 2021.
Under the Appropriations Act, the employee retention credit is extended and will be available for qualified wages paid through June 30, 2021.
Increased Credit Amounts in 2021.
For qualified wages paid in 2021, the Appropriations Act increases the credit percentage from 50% to 70%. In addition, the credit cap for wages paid in 2021 is increased to $7,000 for each of the first two quarters of 2021, so that the maximum credit for 2021 will be $14,000.
Modification of Reduction in Gross Receipts Test for 2021.
For 2021, the test is satisfied for any quarter of the first half of 2021 in which gross receipts is less than 80% of the same quarter in 2019. If a business did not exist at the beginning of the same quarter of 2019, the same quarter in 2020 is substituted. The Appropriations Act also provides the option to elect to satisfy the gross receipts test by looking at the immediately preceding calendar quarter, and comparing that quarter to the corresponding quarter in 2019.
Modification of Definition of Qualified Wages for Large Employers in 2021.
Under the CARES Act, for employers with greater than 100 full-time employees, qualified wages are limited to wages paid to employees when they are not providing services due to the COVID-19-related circumstances. The Appropriations Act increases the threshold number of employees before a change in treatment arises from 100 to 500 in 2021.
Advance of 2021 Credits.
The Appropriations Act directs Treasury to prescribe rules allowing employers with fewer than 500 full-time employees to elect for any calendar quarter to receive an advance payment of the credit for that quarter in an amount not to exceed 70% of the average quarterly wages paid by the employer in 2019.