In response to the COVID-19 crisis, Congress has passed numerous programs aimed at helping small and medium-sized businesses survive the resulting economic downturn. These include grants and loans (which can be forgiven if certain conditions are met) to help businesses experiencing a cash-flow drought in 2020 and the beginning of 2021.
Now that it is 2020 return season, it is time to look at the tax consequences to business owners that received assistance under these programs. In addition, some of the programs are still disbursing funds to assist businesses in 2021.
Paycheck Protection Program
Congress created the Paycheck Protection Program (PPP), part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (PL 116-136), which provides loans to businesses to allow them to meet their payrolls and pay other expenses. The program was initially allocated $349 billion, but this was increased to $669 billion by the Paycheck Protection Program and Health Care Enhancement Act (PL 116-139).
Recipients qualify for forgiveness of indebtedness on a PPP loan equal to the sum of certain costs, including:
- Payroll costs;
- Any interest payments on any covered mortgage obligation (which does not include any prepayment of or payment of principal on a covered mortgage obligation);
- Any payment for any covered rent obligation;
- Covered utility payments;
- Covered operations expenditures;
- Covered property damage costs;
- Covered supplier costs; and
- Covered worker protection expenditures.
(Act Sec. 7A(b) of the Small Business Act (PL 96-354), as redesignated and transferred by Act Sec. 304(b)(1)(A) of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (PL 116-260) and amended by Act Sec. 304(b)(2)(B) of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act)
PPP loans made before January 1, 2020, are referred to as “First Draw PPP Loans.” Those made after December 31, 2020, are referred to as “PPP Second Draw Loans” or “Subsequent PPP Loans.”
Congress also increased the availability of other loans and grants, including Small Business Administration (SBA) 7(a) loans, loans to state and local development companies (504 loans), SBA microloans, Economic Injury Disaster Loan (EIDL) program grants, targeted EIDL advances, and shuttered venue operator grants. These loans and grants are all part of programs started or expanded by coronavirus-related legislation.
7(a) loans are SBA’s most common loan program. They can be used for short- and long-term working capital, refinancing current business debt, and purchasing furniture, fixtures, and supplies. SBA has been making monthly payments on 7(a) loans for up to six months during the COVID-19 crisis. (SBA website: 7(a) Loans)
504 loans are provided through certified development companies (CDCs), who regulate nonprofits and promote economic development within their communities. The loans can be used for major fixed assets that promote business growth and job creation, including the purchase or construction of existing buildings or land, new facilities, or long-term machinery and equipment. As with 7(a) loans, SBA has been making monthly payments on 504 loans for up to six months during the COVID-19 crisis. (SBA website: 504 Loans)
Microloans of up to $50,000 are provided to help small businesses and not-for-profit childcare centers start up and expand. SBA has also been making payments every month for up to six months on microloans for businesses impacted by the coronavirus. (SBA website: Microloan Program)
EIDL program grants (or EIDL advances) were payments provided to EIDL applicants based on the number of employees indicated on an applicant’s COVID-19 EIDL application: $1,000/employee, up to a maximum of $10,000. EIDL program grants are no longer available. (SBA website: COVID-19 Economic Injury Disaster Loan)
Targeted EIDL advances provide businesses in low-income communities who can demonstrate more than a 30% reduction in revenue with up to $10,000. Targeted EIDL advances were introduced in the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act, PL 116-260) and were first provided in 2021. (SBA website: COVID-19 Economic Injury Disaster Loan)
Shuttered venue operator grants are to be provided to live venue operators or promoters; theatrical producers; live performing arts organization operators; relevant museum operators, zoos, and aquariums which meet specific criteria; motion picture theater operators; and talent representatives. Shuttered venue operator grants were introduced in the Economic Aid Act and are anticipated to be available the week of April 18, 2021. (SBA website: Shuttered Venue Operators Grant)
Restaurant revitalization grants are included in recent legislation, the American Rescue Plan Act of 2021 (ARPA or ARP Act, PL 117-2). Under ARPA, restaurants, food trucks, caterers, and similar entities (collectively, “restaurants”) are eligible to receive grants equal to the restaurant’s pandemic-related revenue loss. A pandemic-related revenue loss is the difference between the restaurant’s gross receipts for 2019 and 2020. The grants are funded by the $25 billion Restaurant Revitalization Fund. Restaurants that applied for or received shuttered venue operator grants are not eligible to receive restaurant revitalization grants. A grant recipient may use the grants for payroll costs, mortgage or rent payments, utilities, maintenance and supply costs, food, other supplies, and similar costs. (SBA website: Restaurant Revitalization Fund)
Exclusion from gross income
The following provisions provide that the grants mentioned above, and forgiveness of the loans mentioned above, are excluded from gross income:
- Forgiveness of PPP loans is excluded under Act Sec. 7A(i)(1) of the Small Business Act ( PL 96-354) and Act Sec. 278(a)(1)DivN of the COVID-related Tax Relief Act of 2020 (COVID-related Tax Act, PL 116-260).
- SBA payments of 7(a) loans, 504 loans, and microloans for the benefit of the taxpayer are excluded under Act Sec. 278(c)(1)DivN of the COVID-related Tax Act.
- EIDL program grants and targeted EIDL advances are excluded under Act Sec. 278(b)(1)DivN of the COVID-related Tax Act and in the case of targeted EIDL advances also under Act Sec. 9672(1) of ARPA.
- Grants for shuttered venue operators are excluded under Act Sec. 278(d)(1)DivN of the COVID-related Tax Act.
- Restaurant revitalization grants are excluded under Act Sec. 9673(1) of ARPA.
This income exclusion is an exception from rules that normally require the recognition of income “from whatever source derived” and that specifically require the recognition of cancellation of indebtedness (COD) income (Code Sec. 61(a); Reg § 1.61-12).
Deductibility of expenses
Expenses paid with funds from the loans and grants mentioned above are deductible, notwithstanding the general prohibition on deducting expenses that are reimbursed to the taxpayer. Moreover, taxpayers are not required to reduce their tax attributes or forgo an increase in the basis of an asset because they had the loans described above forgiven or if they received grants described above. (Act Sec. 7A(i)(2) of the Small Business Act; Act Sec. 278(a)(2), (b)(2), (c)(2), and (d)(2) of the COVID-related Tax Act; Act Secs. 9672(2) and 9673(2) of ARPA)
In the case of a loan or grant recipient that is a partnership or S corporation, amounts of grants or forgiveness of the loans described above is treated as tax-exempt income. In other words, the amount of the grant or of the loan forgiveness increases a partner’s adjusted basis in its partnership interest or an S corporation shareholder’s basis in the S corporation’s stock. The amount excluded from gross income is also considered tax-exempt income for purposes of calculating an S corporation shareholder’s accumulated adjustments account. (Act Sec. 7A(i)(3) of the Small Business Act; Act Sec. 278(a)(3), (b)(3), (c)(3), and (d)(3) of the COVID-related Tax Act; Act Secs. 9672(3) and 9673(3) of ARPA)
Illustration: An S corporation has two equal shareholders, Alison and Bob, who each have basis in S corporation stock and debt of $200,000. The S corporation receives a $100,000 PPP loan in 2020, which is forgiven because S spends the money entirely on wages and utility payments, all of which are ordinary and necessary business expenses deductible in 2020. Let’s assume, for the sake of simplicity, that the S corporation has no other tax items. The forgiven debt is not included in the S corporation’s income, and the wage and utility expenses are fully deductible.
The S corporation passes through the forgiven debt through to Alison and Bob as tax-exempt income, which increases their bases by $50,000 each. The S corporation also passes through the deductions to its shareholders ($50,000), which reduces their bases in S corporation stock and debt by like amounts, offsetting the basis increases from the allocations of tax-exempt income. After taking into account the items on their K-1s, Alison and Bob will each have $50,000 deductions, and their bases in S corporation stock and debt will not have changed.
To continue your research on exclusion of COD income on PPP and other subsidized SBA loans discussed above, see FTC 2d/FIN ¶J-7514 et seq. For exclusion of the grants discussed above from gross income, see FTC 2d/FIN ¶J-1299.1. For deductibility of expenses, see FTC 2d/FIN ¶L-1007.1.
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