Countless businesses have utilized the Paycheck Protection Program (PPP) to keep employees on payroll during the shutdowns and restrictions of the pandemic. However, as businesses look to take advantage of the loan forgiveness options, it is important to fully understand the rules and regulations of the program, especially when it comes to the record keeping requirements. Considering there have been modifications to the rules, it’s essential that businesses stay informed.

In addition to being necessary to qualify for loan forgiveness, good recordkeeping can also be important for accurate tax preparation. Having all relevant information clearly organized, readily accessible, and thoroughly documented will help simplify and streamline the process.

Critical Conditions

As established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, PPP funds can only be used for the following purposes:

• Payroll (including salaries, wages, health plan and retirement benefits, and family, medical, or sick leave benefits)
• Mortgage interest or rent payments (provided the mortgage or lease was in effect before Feb. 15, 2020)
• Utility expenses (including traditional utilities, as well as telephone and internet costs)

Eligible expenses must be incurred during a 24-week “covered period,” starting from the day the company first receives PPP funds from its lender. Some early program participants may choose to use an 8-week period instead. Unless Congress modifies the program, the cutoff date for all eligible expenses is Dec. 31, 2020.

To qualify for full forgiveness, recipients must use at least 60 percent of PPP loan proceeds for payroll costs. Companies must also maintain certain staffing and pay levels for individual employees. If a company falls short of the requirements, the forgivable amount will be reduced, but several safe harbors are available if a borrower does not fully meet certain requirements.

Tax Consequences

The proceeds from a PPP loan are not taxable, even if the loan is forgiven. That is an obvious benefit, of course, but it also has potentially negative tax consequences. Even though all businesses routinely deduct payroll, rent, interest, or utility expenses from their taxable income, the IRS has ruled that any expenses paid with funds from a forgiven PPP loan are not deductible for federal income tax purposes.

In announcing this decision, the IRS cited section 265 of the Internal Revenue Code, which states that expenses that would normally be deductible cannot be deducted if they are paid for with tax-exempt funds. “The purpose of section 265 of the Code is to prevent a double tax benefit,” argues the IRS.

Many analysts—and many members of Congress—say this ruling directly contradicts Congress’ intent when it enacted the program. Nevertheless, neither the original CARES Act nor later revisions addressed the question of deductibility, and a Senate bill that would overturn the IRS’s ruling is awaiting action by the Finance Committee. So, for the time being, the IRS ruling stands.

Records and Documentation Checklist

Individual lenders are responsible for handling loan forgiveness applications, so their specific recordkeeping and documentation requirements may vary. At a minimum, a company that received a PPP loan should maintain documents verifying the number of full-time equivalent employees for both the covered periods in 2020 and the comparison periods in 2019, as well as individual employees’ pay rates.

Companies also need to track and record expenses paid with PPP funds separately from other similar expenses. Commonly required documents include the following:

• Company payroll records (many third-party payroll services are developing specific reports for PPP loan forgiveness)
• Federal payroll tax filings (Form 941), along with state payroll tax and unemployment insurance filings
• Documentation of all retirement, health insurance, and other benefit contributions
• Receipts verifying eligible interest, rent, and utility payments, along with documentation showing these accounts were active prior to Feb. 15, 2020

To comply with the extensive documentation required for loan forgiveness, some businesses have decided to pay eligible expenses from a separate bank account. While that isn’t necessary for all businesses, it would be smart to modify the bookkeeping system to keep a separate class or category for PPP expenditures. This will also assist in the delivery of documents to lenders, as most will require them in electronic form.

Please call us to review your company’s specific PPP recordkeeping and documentation requirements.