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The Paycheck Protection Program (PPP) loan process has become increasingly complicated as new guidance and enhancements to the program have been announced. Not only does the guidance continue to change but some of the provisions have retroactive application, such as the availability of 2020 employee retention credits (ERCs) for borrowers of PPP loans.  

How can I maximize the employee retention credit while still achieving full PPP loan forgiveness?

Section 2301(g)(1) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), as amended by the Tax Certainty and Disaster Tax Relief Act of 2020 (Relief Act), allows recipients of PPP loans to also claim the ERC for qualified wages as long as the same expenses are not used for both benefits. IRS Notice 2021-20, issued on March 1, 2021, provides guidance for employers claiming the ERC and indicates that an eligible employer generally makes the election to use payroll costs for PPP loan forgiveness by not claiming the ERC for those qualified wages on its federal employment tax return.
The general rule is fairly easy to apply for PPP borrowers who have not yet applied to have a PPP loan forgiven, because they can make the election on an original or amended federal employment tax return (typically a Form 941). ERC qualified wages are limited to $10,000 for calendar year 2020 and $10,000 for each of Q1 and Q2 of 2021 (note that the American Rescue Plan Act of 2021 (ARP), which was signed into law on March 11, 2021, extends the ERC through December 31, 2021).
The determination of the ERC wage amount for each quarterly return begins with an employee-by-employee analysis of qualified wages paid during each quarter before and after the PPP loan covered period. If the maximum qualified wage amount is paid or projected to be paid outside the PPP loan covered period, then the analysis is complete for that employee and all wages paid to that employee during the covered period can be used for PPP loan forgiveness. If, however, the ERC maximum qualified wage is not reached with respect to wages paid outside the PPP loan covered period, additional analysis is needed to determine whether wages paid during the PPP loan covered period can be designated as ERC wages without affecting total loan forgiveness. It is important to note that total loan forgiveness can be achieved with payroll costs that equal only 60% of the PPP loan as long as there are eligible non-payroll costs paid during the covered period to cover 40% of the loan.  
This process works differently for PPP loan borrowers that have already filed a forgiveness application for a 2020 PPP loan. When these borrowers filed 2020 Q2 and Q3 federal employment tax returns, they were not eligible for the ERC and, at the time the 2020 Q4 return was filed, they had very little information on how to claim the credit. As a result, borrowers generally did not include an ERC qualified wage election on their originally filed 2020 employment tax returns. 
To address this issue, Notice 2021-20 provides that an eligible employer is deemed to have made the election under section 2301(g)(1) of the CARES Act for the amount of qualified wages included in the payroll costs reported on the PPP loan forgiveness application up to (but not exceeding) the minimum amount of payroll costs, together with any other eligible expenses reported on the application, sufficient to support the amount of the PPP loan that is forgiven. Wages and health care costs covered by this deemed election cannot be considered qualified wages for purposes of the ERC.
For example, to simplify the forgiveness process a 2020 PPP borrower with payroll costs of $100,000 and nonpayroll costs of $50,000 reported only payroll costs of $100,000 on its PPP loan forgiveness application. Under Notice 2021-20, the borrower may not include any of the $100,000 of payroll costs as qualified wages in its ERC calculation, notwithstanding that 100% PPP loan forgiveness could have been achieved by reporting only $60,000 of payroll costs and $40,000 of nonpayroll costs.
If the PPP borrower had reported payroll costs of $100,000 and nonpayroll costs of $40,000 on its PPP loan forgiveness application, the deemed election would apply to only $60,000 of payroll costs.
Key takeaway: Unfortunately, borrowers who have already received PPP loan forgiveness do not have the same planning opportunities that are available to borrowers who have not yet filed the loan forgiveness application.

How do I measure gross receipts to determine eligibility for a second draw loan?

Generally, gross receipts for purposes of second draw PPP loan eligibility are defined as all revenue received or accrued by the borrower and its affiliates from all sources. This includes revenue from the sale of products or services, interest, dividends, rents, royalties, fees or commissions, reduced by returns and allowances but excluding net capital gains and losses. Importantly, gross receipts do not include forgiven PPP loan proceeds or economic injury disaster loan (EIDL) advances. Guidance released by the Small Business Administration (SBA) provides a shortcut to calculating gross receipts based on the relevant lines of the tax return.
To be eligible to receive a second draw PPP Loan, the borrower must demonstrate at least a 25% decline in either:

  • Gross receipts in any calendar quarter of 2020 compared to the same quarter of 2019, or
  • Annual gross receipts in 2020 compared to annual gross receipts in 2019.

For entities that were not in business during all of 2019, the decline in gross receipts can be demonstrated starting with the first quarter in which business began if it was before February 15, 2020. For example, applicants that were not in business until the fourth quarter of 2019 should compare the fourth quarter of 2019 to each calendar quarter of 2020 when measuring the decline in gross receipts.
If the requested second draw PPP loan amount is greater than $150,000, the applicant must provide documentation supporting the decline in gross receipts with the loan application. For loan amounts of less than $150,000, SBA allows the documentation to be provided no later than the time the loan forgiveness application is submitted to the lender. Supporting documentation includes quarterly financial statements or quarterly or monthly bank statements. If relying on annual gross receipts, the 2019 and 2020 annual tax filings are required. If the 2020 annual tax filing is not yet available, SBA recommends submitting a mock 2020 return with signatures attesting that the values entered will be the same values included on the filed return.

What’s different about second draw loans in addition to the gross receipts requirement?

Maximum number of employees

Unlike for first draw eligibility, the only definition of small employer for purposes of the second draw is that the employer can have no more than 300 employees. Therefore, an employer that exceeds the 300-employee threshold cannot rely on the size standards established by SBA for purposes of second draw eligibility.
When counting the number of employees, all employees of the borrower and its affiliates (both U.S. and foreign) must be included, unless the borrower satisfies the alternative criteria for businesses with a North American Industry Classification System (NAICS) code beginning with 72 or qualifying news organizations. (The ARP includes provisions that also make more nonprofit organizations eligible for the PPP.) Special rules also apply to franchisees. This is not a full-time equivalent determination. One person equals one employee no matter the hours worked.
SBA does not determine affiliates based solely on ownership. According to SBA guidance, affiliation generally exists when one business controls or has the power to control another, or when a third party (or parties) controls or has the power to control both businesses. Control may arise through ownership, management, or other relationships or interactions between the parties. The totality of the circumstances must be considered when determining which entities are affiliates when applying the 300-employee threshold. 
Key takeaway: Many first draw PPP loan recipients are not eligible for second draw loans due to the requirement that second draw applicants have no more than 300 employees.

Processing delays

The new process implemented by SBA to fight fraud in the PPP program has delayed some loan applications for weeks, resulting in about 30% of the applications being rejected or requiring more documentation. In addition, the loan application approval process for lenders includes various SBA validation and other checks that can result in the application being sent back to the lender or otherwise stalled, including when a lender submits the loan application to SBA via the SBA E-Tran (processing) system, during the SBA underwriting process (where applications may be flagged with any of 40 possible error codes), and during the actual SBA review process. For stalled applications, it can take significant manual effort by lenders and borrowers to rectify error codes and provide additional documentation.
Common error code and validation issues have included:

  •  The imposition of a loan cap of $35,000 per employee for both first draw and second draw applications by the SBA E-Tran system, something not addressed in any of the PPP legislation or SBA’s IFRs or FAQs. This system cap is also causing lenders to reduce the amount of a loan they are approving before sending the loan to SBA.
  • The use of a “doing business as” name (DBA), which may trigger a hold code error for second draw applications even though the DBA was used by the entity in the first draw loan cycle.
  • The requirement for an entity that applies for a first draw loan and then immediately applies for a second draw loan to certify it has or will have used the first draw loan proceeds for eligible expenses prior to the disbursement of the proceeds of the second draw loan.
  • The requirement that the same EIN is used on both the first draw and second draw loan applications. Some sole proprietors (Schedule C businesses) used their social security number (SSN) for first draw loans, but the SBA processing system is now requiring the use of an EIN. Changing from an SSN to an EIN will generate an error and, in some cases, the SBA system is generating an error even where the EINs on the first and second draw applications match.

In an attempt to speed up loan approvals and disbursements while still maintaining the integrity of the program, SBA changed its processing system in February 2021 to give lenders the authority to clear certain codes and to delay some supporting documents until the borrower applies for loan forgiveness. Even with this change, the application process can be very time intensive because lenders and borrowers are still trying to navigate the new process.

Is there any standard language that should be included when replying to a Form 3509 or 3510?

Borrowers that, together with their affiliates, received $2 million or more in PPP loans are required to complete one of two loan necessity questionnaires, either Form 3509 or 3510, depending on whether the borrower is for-profit or nonprofit, respectively. The information that the borrower provides on either form will be used by SBA to assess the borrower’s certification made at the time of the loan application that the economic uncertainty makes the PPP loan necessary to support the borrower’s ongoing operations (the economic uncertainty certification). 
In its PPP Frequently Asked Questions (specifically, FAQ number 53), SBA provides that the borrower’s receipt of the loan necessity questionnaire does not mean that SBA is challenging the economic uncertainty certification, but rather SBA’s assessment of the certification will be based on the totality of the borrower’s circumstances. The economic uncertainty certification is required to have been made in good faith at the time of the first draw PPP loan application, even if subsequent developments resulted in the loan no longer being necessary. In its review, SBA may take into account the borrower’s circumstances and actions both before and after the economic uncertainty certification, to the extent that doing so will assist in determining whether the borrower made the required certification in good faith.
The loan necessity questionnaire makes inquiries that are specific and unique to each borrower to assist SBA in assessing the economic uncertainty certification. The inquiries are centered around two main assessments of the borrower: (i) a business/nonprofit activity assessment, and (ii) a liquidity assessment. The responses to the questions should be based on the borrower’s specific facts and circumstances, and generally these responses do not lend themselves to a standard or canned response. A borrower should make sure that each question is addressed, and if the question is not applicable, the borrower should state this on the questionnaire. At the end of each assessment, the questionnaire provides an optional comment section for the borrower to include additional narrative. Many borrowers view this optional section as a means to address questions where character limits did not allow them to fully complete the response or as an opportunity to address any previous response that may need further context to ensure that the economic uncertainty certification was made in good faith.

How do I account for PPP loans in my financial statements?

There is no specific guidance in U.S. GAAP related to accounting for government assistance by business/for-profit entities. To determine the relevant accounting treatment, entities should analyze the nature and form of the assistance as well as the conditions required to be met.
An entity should first consider accounting principles for similar transactions or events within a source of authoritative U.S. GAAP guidance for that entity and then consider nonauthoritative guidance from other sources.

Loan model

As PPP loans are considered legal-form debt, it is appropriate to account for them as such under ASC 470, Debt. Under this model, the liability would only be derecognized upon (a) repayment to the creditor or (b) legal release under ASC 405-20, Extinguishments of Liabilities. In this context, some entities may repay the PPP loan at the end of two (or five) years upon maturity, or earlier because they have reconsidered their eligibility. In those cases, debt accounting must be applied.
Entities that intend to apply for debt forgiveness should still account for the PPP loan as debt pursuant to the guidance in ASC 470. However, legal release would only occur upon confirmation of forgiveness from SBA. 
Key takeaway
: Borrowers intending to or that have already applied for forgiveness should not derecognize the PPP loan liability until they have received the confirmation of forgiveness from SBA.  

IAS 20 grant accounting model

Alternatively, it may be acceptable to account for PPP loans by analogy to IAS 20, Accounting for Government Grants and Disclosure of Government Assistance. This analogy is only acceptable if:

  •  The entity meets the eligibility requirements to participate in the PPP, which may require legal analysis. Entities with loans under the $2 million safe harbor may be eligible, absent evidence to the contrary.
  • At inception, it is probable the borrower will qualify for forgiveness. In practice, “probable” is commonly understood to mean 75%–80% likely to occur (IAS 20 refers to “reasonable assurance” concerning a recipient’s compliance with the conditions required to receive a grant, which is understood to be synonymous with “probable” under U.S. GAAP).

Under an analogy to IAS 20, a deferred income liability would be recognized upon receipt of the forgivable loan if, at the time of receiving the loan, the entity has determined it is probable the entity would meet the conditions for forgiveness, i.e., the loan will be used to pay for qualifying salaries, rent, mortgage interest and utilities. No interest would be accrued due to the expectation of forgiveness.
The deferred income liability would be derecognized on a systematic basis over the periods in which the entity incurs the related expenses (e.g., payroll). That is, the deferred income would be recognized in the income statement as qualified expenses are paid and presented as either (1) other income or (2) a reduction of the related expenses (presentation as revenue is not appropriate). This approach will result in the recognition of the proceeds as a grant for the amount expected to be forgiven prior to legal release; the remainder (if any) would be recognized as a loan consistent with ASC 470 and derecognized upon repayment or legal release in accordance with ASC 405-20.
Key takeaway: It is important to note that in the context of IAS 20, the assessment regarding eligibility may require significant documentation and the 75%–80% probability hurdle regarding qualifying for forgiveness may be difficult to overcome for many borrowers, as borrowers will need to make this assessment at the inception and monitor on an ongoing basis. In addition, entities should consider whether they have previously established an accounting policy for government grants, which should be applied consistently. If no such policy exists, the selection of a policy to account for a PPP loan will need to be considered for any future forms of government grants received.

Not-for-profit entities

ASC 958-605, Not-for-Profit Entities—Revenue Recognition applies to government grants received by not-for-profit entities. Therefore, no analogy to IAS 20 would be made by not-for-profit entities.

Disclosure considerations

All reporting entities should disclose the applicable accounting policy for PPP and, if applicable, its treatment as forgiven in the footnotes and where the loan amounts are presented in the financial statements.
In addition, SEC registrants should provide appropriate disclosures throughout their filings. Specifically, a risk factor may be appropriate to address eligibility considerations for the PPP loans as well as uncertainties about forgiveness. MD&A liquidity disclosures should discuss the borrower’s intent and ability to repay the loan. When a registrant’s operations are only viable due to the receipt of the PPP loan, that fact should also be disclosed.

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