The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020. Among many things it created the Paycheck Protection Program (PPP) to provide forgivable loans backed by the federal government to qualified small businesses. Since its creation, the Small Business Administration (SBA), who administers the PPP, and the US Treasury have provided ongoing and sometimes daily guidance regarding its various provisions. There are numerous resources available providing guidance on the PPP program, including our COVID-19 Resources Page.
This article is not intended to be a comprehensive review of the PPP but rather a review of some of the provisions with a unique application to the construction industry.
Certification of loan request necessity
One provision of the PPP requires the Borrower to certify that the “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Frequently Asked Question number 31 issued by the Treasury attempts to clarify what this requirement entails. In part, it requires Borrowers to consider their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.
Documentation supporting the basis for certification at the time the Borrower applied for the PPP loan is critical should you be audited. The following are some considerations to review as you create documentation for your files:
- Many construction companies had strong backlogs when the PPP became available. However, the uncertainty of the future availability of new projects and/or projects being canceled or postponed coupled with the limited funding of the PPP prompted many construction companies to apply for the Program.
- Most construction companies have lines of credit with lenders, and many of those have not used the full amount available. This could be considered a source of liquidity but may also be significantly detrimental when considering bonding capacity. Sureties often downgrade highly leveraged construction companies, which would restrict the size and types of jobs that may be bid and/or performed.
- Declines in tax revenues may be harmful to those with significant public sector work as state and local governmental entities wrestle with ways to balance their budgets.
- Unlike other industries, the nature of the construction industry sheltered it from some of the immediate detrimental impacts caused by COVID-19. Should the delay and cancellation of projects continue, however, it will also take time for the industry to ramp back up to pre-COVID-19 levels. Funding to survive in the interim while retaining skilled employees is another consideration.
Of course, one of the benefits of the PPP is the possibility of having the loan partially or completely forgiven (tax free too ... more on that later). Four categories of expenses paid or incurred during a certain period following the funding of the loan are used to determine the amount of the loan that may be forgiven. These categories are:
- payroll costs,
- interest on mortgage obligations,
- rent or lease payments and
- utility payments.
Common construction industry expenses that may be overlooked but can be included in these categories include cell phones, job site utilities, and fuel for equipment and vehicles. In addition, if the agreement was in force prior to February 15, 2020, interest on any loans secured by real or personal property, equipment rent, and internet service are also eligible.
Tax-free treatment of loan forgiveness
An additional benefit provided by the CARES Act is a provision providing for the tax-free treatment of loan forgiveness attributable to PPP loans. Unfortunately, the IRS issued Notice 2020-32 on April 30 indicating that the expenses paid with the forgiven PPP loan proceeds are nondeductible based on the application of long-standing tax law that disallows deductions related to the generation of tax-free income. Since then, legislation has been introduced (but not yet passed) to allow the deductions and preserve the intended tax-free treatment of PPP loan forgiveness.
Given this current situation, there may be some planning opportunities. For example, if the loan is not forgiven until 2021, the deductions related to the forgiveness were paid and presumably deducted on the 2020 return. Guidance is needed to determine if the IRS will require you to treat the same amount of expenses as nondeductible on the 2021 income tax return even though they were actually paid and incurred the prior year. The possibility of deferring the nondeductible expenses until 2021 may result in larger tax savings (not to mention deferral of taxable income) since 2020’s taxable income may very well be higher than 2021 presuming next year is when the pandemic will hit the construction industry hardest.