Many of our clients have taken advantage of the Small Business Administration’s Paycheck Protection Program (PPP). PPP loans are providing essential relief to businesses that might otherwise be forced to cut staff, or worse. With the cash in hand, now is the time to understand how the loan should be treated for accounting and tax purposes.
PPP Loans under U.S. GAAP: Debt or Grant?
U.S. Generally Accepted Accounting Principles (GAAP) do not currently have guidance that specifically addresses the treatment of a forgivable loan from a government entity. Absent specific guidance, it would be acceptable to account for PPP loans as debt under Accounting Standards Codification (ASC) 470 on the basis of their legal form, even if the business expects the loan to be forgiven. Alternatively, a business may have the option of characterizing the loan as an in-substance government grant.
When treating a PPP loan as debt, several accounting principles come into play:
- The full amount of the loan is recognized as a liability.
- Interest is accrued at the program’s specified 1% rate.
- Third-party expenses incurred in connection with the loan, such as professional service fees, can be deferred and amortized over the lifetime of the debt obligation.
- The loan will remain recognized as a debt until the government issues a formal notice of its forgiveness in response to the business’s loan forgiveness application.
- Loan proceeds and repayments are treated as financing activities for cashflow accounting purposes.
Some businesses may be able to characterize their PPP loans as in-substance government grants under International Accounting Standards (IAS) 20. Bear in mind that U.S. GAAP has no provision for treating a forgivable government loan such as those under PPP as grants. Therefore, businesses that must follow a strict GAAP approach may not have this option.
The main objective of accounting for government grants under IAS 20 is for an entity to recognize the grant in the same period or periods in which it recognizes the corresponding costs in the income statement. The grant approach relies in part on the company’s assumption that the loan will be forgiven. In essence, the company’s compliance with the forgiveness requirement is treated as the consideration for an income grant.
On the entity’s income statement, the grant is presented either as a credit to income (in or outside of operating income) or as a reduction in the expense the grant is intended to defray.
When taking the grant approach, a business needs to continuously monitor the likelihood that it will qualify for forgiveness. To the extent that part of the loan proceeds may need to be repaid, the amount booked as income will need to be reversed and instead treated as debt.
The Tax Treatment of PPP Loans
Section 1106(i) of the CARES Act explicitly provides that PPP loan forgiveness will not be treated as taxable income. IRS Notice 2020-32, issued on April 30, clarifies that although the forgiven amount of a loan is not treated as taxable income, qualified expenses paid with the loan proceeds cannot be claimed as deductions.
To qualify for forgiveness, PPP loan proceeds may only be used for qualified payroll, mortgage, rent, and utility expenses. Only 25% of a loan may be used toward non-payroll expenses. Due to the forgiveness provisions, businesses should already be planning to carefully account for how they use the loan proceeds. IRS Notice 2020-32 simply gives another important reason to keep track of how PPP funds are allocated.
Whittaker & Company is here to answer your questions
The team at Whittaker & Company is keeping track of the details around PPP so you don’t have to. Do you have questions about how to account for your business’s PPP loan? Give us a call.