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OC Accountants Interpret Fine Print on Coronavirus Rules

This month marks 28 years since Kim Letch began her career at Ernst & Young LLP.

“So much has changed in the accounting profession over that time, and yet, it pales in comparison to the scale and magnitude of the change that we’ve all witnessed and felt in our lives and businesses over the last three months,” said Letch, who is managing partner in charge of E&Y’s Orange County office.

“All of us—whether you’re a company headquartered in Orange County or London—are facing uncertainty, disruption and the potential for transformation.”

Three months ago, before the coronavirus pandemic, acronyms like PPP and CARES didn’t exist in the accounting world.

Accountants have scrambled in recent months to understand the ramifications of newly enacted programs like the Paycheck Protection Program, which targets firms under 500 employees, and the Main Street Lending Facility, which provides financing to larger companies with up to 10,000 employees or up to $2.5 billion in 2019 revenue.

They are trying to discern the ramifications for state taxes and are diving into the fine print for employee retention credits, economic impact payments and corporate credit facilities.

“In the midst of every crisis, lies great opportunity,” said Meghan Andersson, manager in the tax department at SingerLewak LLP.

“Now is the time to get your management team together to determine where the company is headed, considering lessons learned from this crisis.”

The Business Journal asked top accountants at five Orange County firms for their views and split their answers into categories such as the ubiquitous PPP and the tax ramifications.

“Regardless of the taxation aspects of these programs, many companies are grateful for government assistance received to carry them through these unprecedented times,” said Deborah Dickson, founder and managing partner of Irvine-based Smith Dickson CPAs LLP.

PPP

Shannan Gardner, partner-in-charge, Orange County office, and Frank Kaufman, partner, national practice leader, retail, Moss Adams: The CARES Act, which established the Paycheck Protection Program, specifically states PPP loan forgiveness won’t be considered taxable income to the borrower. However, expenses paid with funds forgiven under the PPP aren’t tax deductible.

Alternatively, most states don’t automatically adhere to federal tax rules because they’re facing huge tax revenue reductions because of the pandemic. And if a company is determined to be insolvent as defined under the tax code, some states require tax attributes, such as net operating losses and credits, be reduced even if the forgiveness income doesn’t result in taxable income and a corresponding tax liability.

The most important element in loan forgiveness program is to stay up to date on daily changes to rules, relevant time frames, and forgiveness strategies.

For example, PPP borrowers can now use a 24-week measurement period versus eight weeks. A client recently said they anticipated 100% forgiveness because the time period tripled. They also expected to make further headcount cuts in the next few months because business isn’t recovering the way they hoped.

After modeling the two scenarios, the eight-week window, with less monies spent, resulted in higher forgiveness. Understanding the rules and how they relate to each company’s facts and circumstances can affect the amount of forgiveness.

Dickson: Three months ago, at the inception of the stay-at-home orders, we heard from clients who ceased operations overnight: international rock concert/sporting events producers; owners of a downtown Los Angeles parking tower management company; many lawyers due to court closures; and well-known touring rock bands.

To help each of these businesses and many others to survive, we worked with them to secure PPP loans.

The allure at the inception of these loans was eligibility for loan forgiveness if the proceeds were used on qualified business expenses, and the loan forgiveness amount was marketed as non-taxable.

A month after the PPP program was implemented, the IRS issued Notice 2020-32 which prohibited a tax deduction for expenses incurred and ultimately forgiven. The IRS ruling effectively made the forgivable part of the loan taxable which did not appear to be Congressional intent in the CARES Act. The American Institute of Certified Public Accountants immediately challenged the surprise ruling. Congress has not yet passed legislation to override this decision.

After this IRS news, some positive changes were legislated. As of this date, to apply for loan forgiveness, 60% (down from 75%) of PPP proceeds must be used to cover payroll or specific benefits, including 401(k) employer contributions and health insurance. The remainder of the business costs must include rent, mortgage interest, or utilities. These costs may be incurred any time within 24 weeks of the loan origination date. This is exciting news for many clients who are hoping to bring back their employees and jumpstart operations when the economy stabilizes.

Letch: The heart of the CARES Act is designed to help companies avoid furloughs and job cuts.

PPP loan recipients will be eligible for loan forgiveness equal to the amount spent by the borrower for the portion of the loan used to cover payroll, interest on mortgage obligations, rent, utilities and interest on pre-existing debt incurred prior to Feb. 15, 2020.

Most recently, the Senate cleared a bill that would make a number of changes to the CARES Act’s $670 billion PPP, including: giving businesses 24 weeks to use the funds, while still qualifying for forgiveness (an increase from the program’s current eight-week limit); increasing to 40% the amount of the loan that can be used for non-payroll costs (up from 25%); and allowing businesses to defer payroll tax payments if they receive a PPP loan.

The employee retention credit, which allows for a credit up to $5,000 per employee, enables OC companies to achieve immediate cash flow to keep their employees on payroll through this crisis. There are, however, various questions on what situations and wages qualify, particularly as the stay-at-home orders lift at different times in various places.

Andersson: PPP loan forgiveness is not included in gross income for federal income tax purposes. However, there is a catch: no deduction is permitted for an otherwise deductible business expense, if payment of the expense results in forgiveness.

The latter rule is intended to prevent a double benefit and is a fair tax treatment of the income and associated deductions. Borrowers should check their applicable state income tax rules to determine whether the amount forgiven will be subject to income tax in their state.

Documentation is the most important element in maximizing loan forgiveness. Do not be afraid to include what you feel is justified, but be ready to support it. A close second is to stay up to date with any changes to the forgiveness rules. For example, a new bill was passed in early June that extends the “covered period” from eight weeks to 24 weeks, lowers the 75% payroll cost threshold to 60%, and extends the loan repayment term from two years to five years.

Tax Implications

Thomas Clarke, OC tax site leader, PWC: The government has acted in a substantial way to help provide businesses a lifeline. A quick summary:

Net Operating Losses (“NOLs”)—The CARES Act included a provision allowing for federal NOLs generated in 2018-2020 to be carried back up to five years while also removing the statutory limitation of 80% of taxable income. Thus, companies may assess if they can generate cash flow from carrying back NOLs to prior years. This also allows for losses incurred while the tax rate is 21% to be carried back to years in which the statutory rate was 35%.

Interest Expense Limitation under Section 163(j)—The CARES Act provides an opportunity to elect relief under Section 163(j) for 2019 and 2020, allowing taxpayers to utilize a threshold of 50% of adjusted taxable income in calculating their interest limitation in lieu of the statutory 30%. Taxpayers will want to consider how this enhanced deduction interplays with other line items on their returns.

Deferral of payroll taxes—The CARES Act allows for the deferral of paying payroll taxes for up to two years. This should generate current cash flow for companies struggling to meet their recent demands. However, if the payment is deferred, deferred taxes may need to be recorded on the unpaid amount as their deductibility might no longer fall under the “recurring item exception.”

Gardner/Kaufman: States, including California, provided taxpayers with mechanisms to defer the remittance of certain taxes, such as sales taxes, property taxes, and employment taxes, to help with short-term needs. However, these mechanisms merely defer the cash tax payment—they aren’t permanent cash tax savings opportunities.

Additionally, with decreases in federal funding, several states proposed legislation that calls for suspension of state net operating losses (NOLs) and limitations on the usage of tax credits. With this type of landscape, many taxpayers are looking for ways to address their state tax liabilities, such as credits and incentives, property tax, and income tax strategies.

PPP Alternatives

Andersson: For companies that do not receive a PPP loan, the employee retention credit against the payroll tax liability can be valuable. The credit is equal to 50% of wages paid, up to a maximum of $10,000 in wages per employee (i.e., maximum credit of $5,000 per employee).

Additionally, all taxpayers can elect to defer their employer’s share of FICA until 2021 and 2022. The CARES Act contains many other tax advantages, such as generous rules on NOL carrybacks, greater flexibility for deducting business interest expense, and more favorable depreciation for qualified improvement property. Companies should reach out to their tax advisors for more information.

Letch: While it’s natural to contract and try to ride this out, companies need to understand the implications of the CARES Act and how it applies to them, regardless of where they are headquartered, because the benefits also help employees.

There’s also some tax relief for companies located internationally, and we’ve created the EY global tax policy tracker to help multinational businesses monitor rapidly emerging government policy and stimulus responses to COVID-19 in international jurisdictions.

Dickson: In addition to PPP loans, there are many other ways to qualify for government funds or loans. These include the employee retention credit up to $5,000 per employee for companies that did not receive PPP funds. These are for wages paid between March 27 and Dec. 31, 2020 if there is a significant decline of gross receipts of 50% or more due to adherence to government orders. Another example is the deferral of the employer portion of Social Security taxes at 50% to Dec. 31, 2021 and 50% to Dec. 31, 2022. Net operating loss carrybacks are now available for losses earned in tax years ending 2018, 2019, and 2020.

What’s Not Getting Attention?

Gardner/Kaufman: One area that has received very little attention is the credit environment with banks.

The $550 billion-plus of PPP loans put in place are 100% guaranteed by the federal government. The general credit environment for nonguaranteed loans is tightening to an extent we haven’t seen in a decade.

Accordingly, lines of credit could be impacted. Private equity groups may not get leverage on transactions, which may impact the number of deals and transaction prices.

Companies shouldn’t assume banking relationships will remain status quo. Now is the time to seek advice and assistance with strategy, reforecasting, and capital and credit exploration.

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Peter J. Brennan
Peter J. Brennan
Peter J. Brennan has been a journalist for 40 years. He spent a decade in Latin America covering wars, narcotic traffickers, earthquakes, and business. His resume includes 15 years at Bloomberg News where his headlines and articles sometimes moved the market caps of companies he covered by hundreds of millions of dollars. His articles have been published worldwide, including the New York Times and the Washington Post; he's appeared on CNN, CBC, BBC, and Bloomberg TV. He was awarded a Kiplinger Fellowship at The Ohio State University.
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