The Paycheck Protection Program (PPP) is the most important COVID-19 related legislation for business owners. With more uncertainty ahead, it is imperative you understand how the forgiveness process will be structured, and the record-keeping challenges that may keep your business from being granted full loan forgiveness.
As the PPP has helped millions of businesses cope with consequences of the COVID-19 shutdown, it has also generated a lot of questions, particularly regarding records that borrowers must keep to qualify for loan forgiveness.
The rules governing PPP loan forgiveness cover a broad range of operational and financial areas, and involve numerous tax and financial reporting documents. Some of the rules have also changed over time, further complicating the record-keeping requirements.
While necessary to qualify for loan forgiveness, good record-keeping can also be important for accurate tax preparation. Having all relevant information clearly organized, readily accessible, and thoroughly documented will help simplify and streamline the process.
As established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, PPP funds can only be used for the following purposes:
- Payroll (including salaries, wages, health plan, or retirement benefits, and family, medical, or sick leave benefits)
- Mortgage interest or rent payments (provided the mortgage or lease was in effect before February 15, 2020)
- Utility expenses (including traditional utilities, as well as telephone and internet costs)
Eligible expenses must be incurred during a 24-week “covered period,” starting from the day the company first receives PPP funds from its lender. Some early program participants may choose to use an 8-week period instead. Unless Congress modifies the program, the cutoff date for all eligible expenses is December 31, 2020.
To qualify for full forgiveness, recipients must use at least 60% of PPP loan proceeds for payroll costs. Companies must also maintain certain staffing and pay levels for individual employees. If a company falls short of the requirements, the forgivable amount will be reduced, but several safe harbors are available if a borrower does not meet certain requirements.
The proceeds from a PPP loan are not taxable, even if the loan is forgiven. This is an obvious benefit, but it also has potentially negative tax consequences. Even though all businesses routinely deduct payroll, rent, interest, or utility expenses from their taxable income, the IRS has ruled that any expenses paid with funds from a forgiven PPP loan are not deductible for federal income tax purposes.
In announcing this decision, the IRS cited section 265 of the Internal Revenue Code, which states that expenses that would normally be deductible cannot be deducted if they are paid for with tax-exempt funds. “The purpose of section 265 of the Code is to prevent a double tax benefit,” argues the IRS.
Many analysts—and many members of Congress—say this ruling directly contradicts Congress’ intent when it enacted the program. Nevertheless, neither the original CARES Act, nor later revisions addressed the question of deductibility, and a Senate bill that would overturn the IRS’s ruling is awaiting action by the Finance Committee. So, for the time being, the IRS ruling stands.
Records and Documentation Checklist
Individual lenders are responsible for handling loan forgiveness applications, so their specific record-keeping and documentation requirements may vary. At a minimum, a company that received a PPP loan should maintain documents verifying the number of full-time equivalent employees for both the covered periods in 2020, and the comparison periods in 2019 – as well as individual employees’ pay rates.
Companies also need to track and record expenses paid with PPP funds separately from other similar expenses. Commonly required documents include the following:
- Company payroll records (many third-party payroll services are developing specific reports for PPP loan forgiveness)
- Federal payroll tax filings (Form 941), along with state payroll tax and unemployment insurance filings
- Documentation of all retirement, health insurance, and other benefit contributions
- Receipts verifying eligible interest, rent, and utility payments, along with documentation showing these accounts were active prior to February 15, 2020
Most lenders will require electronic delivery of these documents. To keep things organized and accessible, the best approach is to set up a separate class or category of accounts for recording PPP-related expenses in the company’s bookkeeping system. Some companies may choose to pay eligible expenses from a separate bank account.
We are here to help. Please call us to review your company’s specific PPP record-keeping and documentation requirements as they may vary by organization.