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Treatment of Business Expenses Paid with PPP Loan Funds

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In December 2020, Congress passed the Consolidated Appropriations Act, 2021. The Act includes the COVID-related Tax Relief Act of 2020, which provides for the full deductibility of business expenses paid with PPP loan funds.

A Refresher: What are PPP Loans?

The Paycheck Protection Program (PPP) is a Small Business Association (SBA)-backed loan to help businesses retain employees during the Coronavirus pandemic. It was enacted under the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020. Funds from PPP loans can be used for payroll, benefits, and some non-payroll-related expenses like mortgage interest, rent, utilities, etc.

Deductible or Nondeductible?

The CARES Act addressed forgiveness of PPP loans used for payroll and other eligible expenses. The Act also stated that a forgiven PPP loan was not taxable income. However, the Act did not specify whether business expenses paid with a PPP loan were deductible.

One month after PPP loans began to be distributed, the Internal Revenue Service (IRS) published Notice 2020-32, offering guidance regarding the deductibility of PPP loan-funded business expenses. The IRS ruled that business expenses that were normally deductible would not be deductible if those expenses were paid for with forgiven (or forgivable) PPP loan funds.

PPP loan-funded-expenses were paid from what is considered tax-exempt income in the form of the forgivable PPP loan. Making PPP loan-funded business expenses deductible was “double-dipping” and was not permitted.

The IRS further released guidance on the topic in November 2020 that reaffirmed their position that business expenses paid with a forgiven (or forgivable) PPP loan were not deductible.

Congress Steps In

In early December 2020, the Office of Advocacy held a roundtable discussion about PPP loan issues. It was determined at that meeting that the IRS decision about the deductibility of business expenses paid with PPP loans fell short for businesses. Congress stepped in and revised the law so that business expenses paid with forgiven (or forgivable) PPP loans are deductible, as are business expenses paid with emergency Economic Injury Disaster Loan (EIDL) funds and targeted EIDL advances.

Small Business Health Care Tax Credit

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Eligible small employers who provide health care coverage to their employees can receive a Small Business Health Care Tax Credit from the federal government. Here is what you need to know about who qualifies and how to take advantage of the credit.

What is the Small Business Health Care Tax Credit?

Small business owners make numerous decisions about employee benefits. For example, the type of benefits offered can entice the most desirable candidates to apply for their company’s positions. The right type of benefits can also boost employee retention. An excellent employee benefit to consider is health insurance. In considering whether to offer health insurance to your employees, you should consider the impact of the the small business health care tax credit. The tax credit is limited to employers with less than 25 employees, and it operates as a sliding-scale credit based on the size of the employer. The larger the employer, the smaller the tax credit. The maximum credit is 50 percent of premiums paid (35 percent for tax-exempt employers).

Qualifying small employers can take advantage of the small business health care tax credit for two consecutive tax years. The credit can also be carried forward or back to other tax years. Any excess amount paid for health insurance premiums over the allowable credit can be claimed as a business expense.

Who qualifies for the Small Business Health Care Tax Credit?

As mentioned above, the small business health care tax credit is for small employers with fewer than 25 full-time equivalent employees (FTE). Note that the FTE concept is based on hours worked rather than the actual number of employees.

Other qualifications include:

The employer pays less than $50,000 a year per FTE in average wages.

The employer offers a qualified health plan to employees through a Small Business Health Options Program Marketplace.

The employer pays at least 50 percent of the employee’s premium cost.

What about Tax-exempt Organizations?

Tax-exempt organizations are also eligible for the small business health care tax credit. In this case, the credit is refundable to the extent that it does not exceed income tax withholdings or Medicare tax liability. Refunds to tax-exempt organizations are reduced by the current fiscal year sequestration rate. For an explanation of sequestration and how it impacts the small business health care tax credit, consult your tax advisor or accountant.

How do small businesses take advantage of the Small Business Health Care Tax Credit?

To claim the small business health care tax credit, the IRS requires Form 8941 (Credit for Small Employer Health Insurance Premiums) to be filled out and submitted. For small businesses, the amount should be included as part of the general business credit on the company’s federal tax return. The amount should be included on Form 990-T (Exempt Organization Business Income Tax Return) for tax-exempt organizations. Note: this form must be filed for a tax-exempt organization to claim the small business health care tax credit, even if the business does not typically file that form.

We are available to assist you determine your eligibility for this credit and to calculate the full amounts that you will be able to claim.

Employee Retention Tax Credit

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Eligible employers are entitled to an Employee Retention Tax Credit (ERTC) of up to 70 percent of the first $10,000 in wages and certain health care plan expenses paid per employee for each of the first two quarters of 2021. This is in addition to an ERTC of up to 50 percent of the first $10,000 in wages and certain health care plan expenses paid per employee between March 13, 2020 and December 31, 2020.

What is the Employee Retention Tax Credit?

Designed to incentivize businesses to keep employees on the payroll during the pandemic, the ERTC is a fully-refundable tax credit that is part of the federal government’s COVID-19 relief plan. As part of this plan, the Taxpayer Certainty and Disaster Tax Relief Act of 2020, which became effective January 1, 2021, amends and extends the former ERTC and the availability of advance payments of the tax credits under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

Is My Company Eligible for the ERTC?

Previously, employers could only take advantage of the Paycheck Protection Program (PPP) OR the ERTC, so the ERTC was not widely used. However, Congress revised this provision to make both plans available to qualifying businesses.

There are two periods for which a business can claim the ERTC: (1) during the period the business has suffered a significant decline in revenue and (2) during the period the business’ operations are fully or partially suspended by a governmental order related to COVID-19.

Small businesses that suffered a revenue reduction in 2020 or 2021 can claim the ERTC. A revenue reduction specifically means a business experienced a decline in gross receipts by more than 20 percent in any quarter of 2021 compared to the same quarter in 2019 (or the previous quarter). A gross receipts decline of at least 50 percent is necessary to claim the credit for 2020.

Further, the tax credit applies to employers, including tax-exempt organizations, that conducted business during 2020 and were forced to fully or partially suspend operation during any quarter due to governmental orders related to COVID-19.

How is the Maximum Amount of ERTC Determined?

Eligible employers are entitled to a tax credit equal to 70 percent of the first $10,000 in wages and qualifying health plan expenses paid per employee for each of the first two quarters of 2021 (up to $14,000).

In addition, eligible employers are entitled to receive a tax credit equal to 50 percent of the first $10,000 in wages and qualifying health plan expenses paid per employee between March 13, 2020 and December 31, 2020.

Note that the combined maximum $14,000 credit for the first two quarters of 2021 is available even if the employer previously received the $5,000 maximum credit for wages paid in 2020.

What are Qualified Wages?

Qualified wages are wages, compensation, and qualified health plan expenses paid by an eligible employer after March 12, 2020 and before July 1, 2021 during periods where the business suffered a significant decline in revenue and during periods where the business’ operations were fully or partially suspended by a governmental order related to COVID-19.

Number of Employees Matters

For 2020, companies with 100 or fewer employees may claim the ERTC for all wages paid to employees while the employer is an eligible employer. For 2021, the threshold is increased to 500 employees.

Still, businesses who have more than these respective numbers of employees are eligible to claim the ERTC for all qualified wages, compensation, and health plan expenses paid to employees who are not providing services due to a suspension of operations due to governmental orders related to the coronavirus disease. No matter the size of your business, you can claim the ERTC if you continued to pay your employees while they could not work due to a

Other Notable Changes to the ERTC

  • Previously, governmental entities were not eligible for the ERTC under the CARES Act; however, under the New Stimulus Act this tax credit is available to state or local run colleges, universities, and organizations providing medical or hospital care.
  • While businesses with a PPP loan now qualify for the ERTC, the tax credit may not be claimed on wages used for PPP loan forgiveness.

How to Claim the ERTC

Amounts of ERTC are claimed on Form 941, Employer’s Quarterly Federal Tax Return. Although Forms 941 have already been filed for 2020, eligible businesses may file claims for refund to obtain amounts of ERTC to which they are entitled for 2020.

A determination of whether you meet each of the above requirements to receive the maximum federal tax credit allowable requires a detailed legal analysis. Contact me today so that I can assist you to: (1) determine the amount of tax credit that you are entitled and (2) file claims with the IRS to obtain those credits.

Business Meals are Deductible Again: Here’s What You Need to Know

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The Consolidated Appropriations Act of 2021 brings a favorite business tax deduction back to life. The so-called “three-martini lunch” is in vogue once again; however, not everyone is happy about it. So, what does this mean for businesses? Read on to learn more about the deduction and the associated pros and cons.

What is the Three-Martini Lunch Tax Deduction?

There was a time – up until the mid-1980s – that business owners and executives could take a 100 percent tax deduction for entertaining clients, colleagues, or even themselves (as it was not unheard of for personal expenses to be grouped in with “business expenses”).

The somewhat scoffing name of the deduction – the Three-Martini Lunch – comes from these lavish “business expenses” that sometimes included leisurely lunches (complete with cocktails), rounds of golf, sporting event tickets, and even vacations. However, under tax laws at the time, as long as the activities were conducted in the name of entertaining clients, they could be deducted on a business’ federal return.

What Changed?

The Tax Reform Act of 1986 eliminated or significantly reduced many tax deductions, including putting a severe halt to businesses’ total deductions for entertaining potential or current clients. Beginning in 1987, the business meal deduction decreased from 100 to 80 percent. Further, the Act called for any part of the meal that was considered “lavish and extravagant” to be excluded from the amount used to calculate the deduction (although no accurate guidance was provided on what constituted “lavish and extravagant”).

Over the years, the deduction was further reduced, and finally, the Tax Cuts and Jobs Act (TCJA) of 2017 repealed the entertainment allowance and scaled the business meal deduction down to 50 percent. The deduction applied only to expenses encountered during actual business activities or active discussions.

Of course, there were caveats and loopholes associated with the changes; however, those loopholes no longer seem necessary as, after more than 30 years, the 100 percent deduction is restored. This increase is due to the Taxpayer Certainty and Disaster Tax Relief Act of 2020, part of the Consolidated Appropriations Act of 2021 (CAA 2021).

The Consolidated Appropriations Act of 2021

The Act increases the deduction to 100 percent so that businesses can deduct the total cost of business meals on federal taxes. This increase in deduction occurred by way of an amendment to the Tax Reform Act of 1986 that makes an exception to the 50 percent rule until January 1, 2023.

What You Should Know

For expenses to be fully deductible, they must be paid or incurred during 2021 or 2022, and the food and beverages claimed must be provided by a restaurant. The Act does not explicitly apply this full deduction to entertainment expenses. Intended to help the flailing restaurant industry during the global pandemic, the Act leaves many business personnel with questions. For example, what constitutes a “restaurant”?

For some guidance, Section 4.01 of Part III of the IRS procedural guide for taxpayers who own or operate a restaurant or tavern deems a “restaurant” to be a place where “food and beverages are prepared to customer order for immediate on-premises or off-premises consumption. Examples are full-service restaurants, limited-service eating places, cafeterias, special food services (like food service contractors, caterers, and mobile food services), and bars, taverns, and other drinking places.”

Another question taxpayers are asking is how should non-food and beverage expenses be handled? (there is no accurate guidance on entertainment expenses).

As you consider these and other questions regarding the new deduction guidelines, also consider some of the proposed pros and cons of the ruling.

Pros and Cons of the Three-Martini Lunch

Returning to a full deduction for business meals and entertainment has been praised and criticized regarding how the change will impact businesses and the economy in general.

Some suggested benefits include:

  • An increase in business will help restaurants and bars reopen in the time of the global pandemic.
  • New employment for those out of work and reemployment for furloughed food service employees.
  • A limited-time (two-year) action to bolster the foodservice industry during the pandemic.

Some of the criticisms of the Act are that:

  • This deduction robs tax relief funds that are more important.
  • It could be challenging to eliminate the deduction when the two-year limit comes.
  • The benefit will extend only to the wealthy who do not need immediate tax relief.
  • Only large, high-end restaurants that serve wealthy business clientele will benefit.

These and other points of interest – as well as many questions – will likely arise as the tax year unfolds. To address these, it is always best for business owners to consult with a tax professional.