PPP Deductions Sanctioned by Congress and Other Business Tax Provisions of the COVID Relief Bill
On December 27, 2020, President Trump signed the COVID-related Tax Relief Act of 2020 (the “COVID Relief Act”), which was enacted as part of the Consolidated Appropriations Act of 2021. While the most exciting part of the COVID Relief Act for taxpayers may be the provision that allows deductions for expenses funded by the Paycheck Protection Program (“PPP”) loans in circumstances where all or a portion of the PPP loan is forgiven, other important business tax provisions were also adopted.
I. Business Owners Happy to See PPP Deductions
In a highly anticipated move, the COVID Relief Act allows businesses that receive PPP loans to deduct from taxable income expenses funded by such loans, even when the loans are subsequently forgiven in whole or in part. See here for our explanation of the new PPP program under the Economic Aid Act -- which was passed under the same bill as the COVID Relief Act.
When PPP loans were originally introduced by the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, provided certain conditions were satisfied, loan recipients received tax-free forgiveness of PPP loans. Unfortunately, the CARES Act was silent on whether the expenses funded by forgiven loans would be tax deductible. Before passage of the COVID Relief Act, the Internal Revenue Service (“IRS”) issued guidance (Notice 2020-32 and Revenue Ruling 2020-27) that disallowed deductions for federal income tax for expenses funded by PPP loans if the taxpayer reasonably expected to receive forgiveness of the loan. Under this guidance, deductions incurred in 2020 and funded by PPP loans were disallowed, even if the taxpayer had not yet applied for forgiveness in 2020, but expected to apply for forgiveness in 2021. The expense deduction disallowance in the guidance was based on case law as well as Section 265(a) of the Internal Revenue Code, which disallows deductions for amounts that are allocable to tax-exempt income. Many tax practitioners argued that the IRS guidance was incorrect and did not address the fact that the loan forgiveness may occur in a year subsequent to the incurrence of the expenses in question.
The COVID Relief Act introduced a legislative fix that many were hoping to see. It states that “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied,” because of the tax-free forgiveness of PPP loans. After months of uncertainty, taxpayers with PPP loans should be very pleased with the clarity provided by the COVID Relief Act. Deductions funded by PPP loans are expressly allowed for the first wave of PPP loans, which occurred in 2020, as well as the second wave to occur in 2021. If a loan recipient is a partnership or S corporation, any amount of PPP loan forgiveness that is excluded from income is treated as tax-exempt income for purposes of Sections 705 and 1366 of the Code. This means that the amount of the PPP loan which is forgiven increases a partner's adjusted basis in its partnership interest or an S corporation shareholders' basis in its S corporation stock and debt.
Shortly after the COVID Relief Act was enacted, the IRS blessed the deduction of expenses funded with PPP loan proceeds in Revenue Ruling 2021-2. The new guidance obsoleted prior IRS guidance in Notice 2020-32 (covered here) and Revenue Ruling 2020-27, which disallowed the deductions.
While the COVID Relief Act clarifies the federal tax treatment of expenses funded with PPP loans, it cannot be assumed that states will conform to federal tax treatment concerning the deductibility of expenses made with forgiven PPP loans. In the absence of specific CARES Act and COVID Tax Relief Act guidance from states – whether by formal legislation or informal administrative guidance - existing state law governs and may vary from federal law.
II. Employee Retention Credit Extended into 2021 and Coordination with PPP
The COVID Relief Act also included important updates to the Employee Retention Credit (“ERC”), including the possibility for taxpayers to receive a PPP loan and an ERC for 2020 and 2021.
Enacted by the CARES Act, the ERC provides a tax credit to qualified employers for up to 50% of the wages paid to employees (with a maximum credit of $5,000 per employee). Employers qualify for the ERC if they fully or partially suspended operations as a result of a government order or their gross receipts declined by more than 50% compared with the same quarter of the prior year.
The COVID Relief Act made several changes to the ERC:
- It extended the ERC to apply to wages paid from January 1, 2021 through June 30, 2021.
- It increased the amount of the ERC from 50% to 70% of qualified wages.
- It increased the 100-employee limitation to 500 employees.
- It increased the $10,000 annual cap on eligible employee wages to a $10,000 quarterly cap on eligible employee wage.
- It allows employers who received PPP loans to take ERC credits and outlines the rules for allocating wages to each program. The CARES Act originally did not allow employers who received PPP loans to take any credits under the ERC. Employers can now both receive PPP loans and qualify for the ERC, but wages used to calculate the ERC cannot be used to support PPP loan forgiveness. If wages could qualify for PPP loans and the ERC, the employer may elect to apply those wages to either the PPP loans or the ERC, but not both. Therefore, with some tax planning, businesses can take advantage of both programs. This change regarding the interaction with PPP loans is retroactive -- treated as if it were included in the original CARES Act, and so is applicable during 2020 (retroactive to the effective date of the CARES Act).
Because of the new retroactive overlap between PPP loans and the ERC, some taxpayers may be able to apply for a refund of taxes paid during 2020. Employers should review their payroll costs to determine how much should be allocated to the PPP payroll costs and how much should be allocated to the ERC calculation to allow for the best outcome.
III. Extends Employer-Paid Family and Medical Leave Tax Credits
Under the Families First Coronavirus Response Act (“FFCRA”), eligible employees of certain employers are entitled to up to 12 weeks of job-protected leave if they are unable to work due to certain reasons related to COVID-19. To alleviate the cost to employers of providing such paid leave, the FFCRA provides employers with a tax credit against the employer’s portion of Social Security taxes. The tax credit is equal to 100% of the paid leave wages required to be provided under the FFCRA. The COVID Relief Act extends the eligibility period for FFCRA credits -- making them available to employers who provide FFCRA paid family and medical leave through March 31, 2021. However, the COVID Relief Act does not mandate that employers provide FFCRA paid leave, and that mandate expired on December 31, 2020. Thus, after December 31, 2020, employers may voluntarily provide FFCRA paid leave to employees and will be remain eligible to receive the tax credit under the FFCRA with respect to such paid leave.
IV. Business Meals Are Temporarily 100% Deductible
Prior to the COVID Relief Act, deductions for expenses paid or incurred for business meals were limited to 50% of the amount incurred. The COVID Relief Act temporarily removes that limitation for food or beverages provided by a restaurant if the expenses are paid or incurred after December 31, 2020 and before January 1, 2023. In 2023, the business meal deductions will once again be limited to 50%.
V. Payroll Deferral Payback Period Extended
The CARES Act provided for a deferral of the employer portion of payroll taxes on wages paid in 2020. Half of the deferred employer portion of payroll taxes will be due at the end of 2021 and the other half at the end of 2022. Later, Notice 2020-65 provided for a deferral of the employee portion of payroll taxes. See our prior article here. The Notice instructed taxpayers that the deferred portion of the employee portion of 2020 payroll taxes must be repaid between January 1, 2021 and April 30, 2021.
The COVID Relief Act extends the payback period for the employee portion of 2020 payroll taxes to December 31, 2021. Therefore, the repayment period is now a full year, rather than four months, causing the per-paycheck deduction to be reduced. However, there is no additional payroll tax deferral for wages paid after 2020. Also, there is no further extension for the payback period for the deferred employer portion of payroll taxes.
Note: The CARES Act originally barred employers who received PPP loans from deferring the employer portion of their payroll taxes, but under the PPP Flexibility Act in summer 2020, that limitation was removed. Employers who deferred 2020 payroll taxes can still take PPP loans and apply for forgiveness.
VI. CARES Act Provisions Not Extended
While the COVID Relief Act extended and expanded PPP loans and the ERC, it is important to note that not all CARES Act provisions were extended.
The CARES Act included two favorable rules applicable to net operating losses (“NOLs”). These provisions will not continue to be effective for tax years beginning after December 31, 2020. Specifically, the CARES Act removed the 80% limitation on the amount of NOL carryovers that can be deducted in 2018, 2019 and 2020 (for calendar year taxpayers). That limitation will return for tax years beginning after December 31, 2020. Also, the CARES Act provided that an NOL that arose in a tax year beginning after December 31, 2017 and before January 1, 2021 could be carried back five years. The ability to carryback NOLs is eliminated for tax years beginning after December 31, 2020.
For tax years 2018, 2019 and 2020, the CARES Act also temporarily suspended the limitation on excess business loss limitations which had been enacted under the 2017 Tax Cuts and Jobs Act (“2017 Tax Act”). This suspension was not extended beyond 2020, which means the limitation will again apply in 2021 through 2026. The limitation on excess business losses applies to noncorporate taxpayers (which include individuals, estates and trusts). Generally, an excess business loss is the excess of (i) the taxpayer's aggregate trade or business deductions for the tax year over (ii) the sum of the taxpayer's aggregate trade or business gross income or gain plus $250,000 ($500,000 in the case of married filing joint taxpayers).
The CARES Act implemented a temporary increase in the limitation on the deduction of business interest expense under Section 163(j) of the Code. Under the 2017 Tax Act, the deduction of business interest expense was limited to (i) 100% of the company's business interest income plus (ii) 30% of adjusted taxable income (computed without taking into consideration business interest income). The CARES Act increased the 30% limit to 50% for tax years beginning in 2019 and 2020. The COVID Relief Act did not extend the increase and thus, the limitation on business interest will revert back to 30% in 2021.
The COVID Relief Act extended several important existing tax incentives, including:
- New Markets Tax Credit: This program provides a federal tax credit for investors in low-income communities. The COVID Relief Act extends the credit through 2025, providing $5 billion per year starting in 2020. It also extends the carryover of unused limitation from 2025 to 2030.
- Work Opportunity Tax Credit: This program offers federal tax credit for employers who hire individuals from certain targeted groups. It had been set to expire on December 31, 2020, but is extended through December 31, 2025.
- Empowerment Zone Designations: This program designates certain distressed urban and rural areas which qualify for special tax incentives, such as first year expensing and credits for qualified wages. The designation is extended through 2025 instead of 2020.
- Employer Credit for Paid Sick and Family Leave: The employer income tax credit under the 2017 Tax Act for employer-provided sick leave and family leave has been extended to December 31, 2025.
- Indian Employment Credit: The Indian Employment Credit, provided to qualified employers of an enrolled member of an Indian tribe, is extended to December 31, 2025.
- Energy Production Credits: Several energy production credits under Section 45 of the Code and the election to treat qualified facilities as energy property are extended to December 31, 2021.
Many more extensions were included in the COVID Relief Act that are not listed here. For more information, please contact your Quarles & Brady attorney or: