Birmingham Business Alliance COVID-19 Re-opening the Local Economy Fred McCallum Birmingham Business Alliance Interim President and Chief Executive Officer Retired President, AT&T Alabama 505 20th Street North, Suite 200 Birmingham, AL 35203 (205) 324-2100 [email protected] 2 Tax Implications of Paycheck Protection Program (PPP) Loan Forgiveness Steve Smith BMSS Advisors & CPAs Member 1121 Riverchase Office Road Birmingham, AL 35244 (205) 982-5500 [email protected] 3 Statutory Language of the Keeping American Workers Paid and Employed Act (Title I of the CARES Act) • §1106(c) TREATMENT OF AMOUNTS FORGIVEN.— (1) IN GENERAL.—Amounts which have been forgiven under this section shall be considered canceled indebtedness by a lender authorized under section 7(a) of the Small Business Act (15 U.S.C. 636(a)). • §1106(i) TAXABILITY.—For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income. 4 § • §265(a)(1) generally provides that no deduction will be allowed for expenditures allocable to income wholly exempt from taxes • §1106 includes no reference to IRC §265 • What was Congress’ intent by its silence on §265 and the deduction side • Joint Committee on Taxation (JCT) Description of the Tax Provisions of the CARES Act (released 4.23.2020) – in discussing §1106 under the heading “Federal tax consequences” the JCT simply restates the language of 1106(i) - no reference to deductions for expenditures that are related to the forgiven loan amount 5 § • §265 disallowance is perhaps most often encountered and identified with tax-exempt investment income (e.g., municipal bond income) but broader than that … • 1988 Tax Court case held that a Native American could not deduct his farming expenses since the income from his farm on tribal reservation land was exempt from tax • 1983 IRS revenue ruling held that a student could not deduct otherwise deductible education expenses because the student funded the expenditures from the proceeds of scholarships that were excluded from income 6 • IRC §108 generally applies to income from discharge of indebtedness • Income does not include discharges in bankruptcy or insolvency • Trade off for exclusion from income is that taxpayer must reduce certain tax attributes, such as NOL carryovers, business credit carryovers, basis other tax attributes • Is it an either / or with respect to IRC §§ 265 limitation on deductions and 108 tax attribute reductions? 7 Portions of Loans Not Forgiven - “Regular” Treatment for Loan Proceeds and Expenditures Funded with Proceeds Partnerships (tax classification) • Loan is nonrecourse – will be allocated to partners under rules for non-recourse debt and to extent so allocated will increase a partner’s basis • Nonrecourse – no increase in partner at risk amount • Deductions for interest on loan and expenditures funded with loan proceeds will be included in trade or business income, and affect partner basis accordingly 8 Portions of Loans Not Forgiven - “Regular” Treatment for Loan Proceeds and Expenditures Funded with Proceeds S corporations • Loans by third parties to S corporations generally do not increase an S corporation shareholder’s basis in stock (but see Selfe case and subsequent developments) • Deductions for interest on loan and expenditures funded with loan proceeds will be included in trade or business income, and affect partner basis accordingly 9 Portions of Loans Forgiven Partnerships (tax classification) • Exclusion from income but deductibility of funded expenses uncertain • A partner's outside basis for his partnership interest is increased by his distributive share of … tax- exempt income of the partnership • a partner's outside basis is decreased (but not below zero) by … (his distributive share of partnership losses and nondeductible expenditures of the partnership “not properly chargeable to capital account.” • Should be a wash for outside partner basis purposes assuming tax-exempt income and non- deductible /deductible expenditures are allocated proportionately to members 10 Portions of Loans Forgiven S corporations • Exclusion from income but deductibility of funded expenses uncertain • Stock basis is increased by the stockholder's share of …separately stated items of income (including tax-exempt income), • Stock basis is decreased by the stockholder's share of … nondeductible corporate expenses or credit that the separate treatment of which could affect the tax liability for tax of any shareholder • Should be a wash for outside shareholder basis purposes given that tax-exempt income and non-deductible /deductible expenditures are allocated proportionately to S shareholders 11 • §1106 of the CARES Act does not constitute an amendment to the Internal Revenue Code (IRC), as do some others sections of the CARES Act. • So even for states with a rolling conformity to the IRC, some action (legislation or ruling) by states may be necessary to provide an exclusion from income of PPP loan forgiveness • Potential issue for action by ruling – could such a ruling be challenged by beneficiaries or recipients of the tax revenue lost by excluding forgiveness 12 A draft bill, currently with the name the “Alabama Taxpayer Stimulus Freedom Act of 2020” is circulating – key components – any amount of loan forgiveness under §1106: • shall be excluded from income for Alabama purposes to same extent as under federal law • shall not be considered in determining the deductibility of otherwise deductible expenses to same extent as under federal law • shall also be excluded from any calculations in determining a taxpayer’s federal income tax deduction 13 Another component of “Alabama Taxpayer Stimulus Freedom Act of 2020” provides that any tax credits or advance refund amounts received by individuals under the CARES Act: • shall be excluded from income for Alabama individual income tax purposes • shall be excluded from any calculations in determining a taxpayer’s federal income tax deduction 14 Paycheck Protection Program (PPP) Loan Forgiveness (SUBJECT TO CHANGE BASED ON ADDITIONAL SBA GUIDANCE) APRIL 30, 2020 Bill Lorimer, CPA Mark Underhill, CPA, CM&AA BMSS Advisors & CPAs BMSS Advisors & CPAs Member Senior Manager 1121 Riverchase Office Road 1121 Riverchase Office Road Birmingham, AL 35244 Birmingham, AL 35244 (205) 982-5500 (205) 982-5500 [email protected] [email protected] 15 • PPP Update and Overview • Covered Period and Forgivable Uses of Funds • Calculation of Loan Forgiveness • Forgiveness Process • PPP Considerations • Additional Guidance Needed • Unforgiven Loan Treatment 16 • Initial funding of $349B in the CARES Act was fully utilized in the first 13 days of the program through issuance of over 1.6M PPP loans. • The Paycheck Protection Program and Health Care Enhancement Act signed into law Friday, April 24th • Adds $310B more to PPP • $30B reserved for lenders with assets under $10B • $30B reserved for lenders with assets $10B - $50B • Enhancement Act provided no other changes or clarifications to original CARES Act rules for PPP • SBA began accepting PPP applications from lenders Monday, April 27th at 9:30 a.m. CST with the system crashing within one hour of opening. • It is anticipated that this round of funding may be exhausted faster than the initial round due to a backlog of applications. 17 home.treasury.gov/policy-issues/cares/assistance-for-small-businesses 18 • Recent pressure on larger companies to return funds • Ruth’s Chris - $20M returned • Shake Shack - $10M returned • Los Angeles Lakers - $4.6M returned • More than 200 publicly traded companies received at least $870M in PPP loans according to SEC filings. • Over $2 billion has already been returned. • SBA has not disclosed who was approved for PPP loans and the amount received although numerous organizations have filed Freedom of Information Act requests for this information. 19 • Competing viewpoints: • "When a wildly successful sports franchise that can afford to pay Lebron James nearly $40 million a year is being shamed into returning paycheck protection program funds, the question we should be asking is why the White House and Congress haven't been more prescriptive about who and what can qualify for help.” – Kyle Herrig, President of Government watchdog group, Accountable • "I never expected in a million years that the Los Angeles Lakers, which, I'm a big fan of the team, but I'm not a big fan of the fact that they took a $4.6 million loan. I think that's outrageous and I'm glad they returned it or they would have had liability.” – Treasury Secretary Steven Mnuchin • Treasury Secretary Mnuchin pledged a “full audit” of loans that are worth more than $2 million before there is loan forgiveness and said borrowers will face criminal liability if they misled the federal government. 20 • Secretary Mnuchin went on to say, “The certification was very clear in saying that if people had other sources of liquidity, they could not take this loan.” • CARES Act passed March 27, 2020 included the following certification language: • An eligible recipient applying for a covered loan shall make a good faith certification that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient; acknowledging that funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments.