Recently released IRS Notice 2021-20 (the “Notice”) provides guidance on the interaction between the Paycheck Protection Program (“PPP”) and the employee retention credit. Unfortunately, the Notice may limit the ability of many PPP borrowers to claim an employee retention credit that employers may have believed they would be entitled to claim.
Under the Coronavirus, Aid, Relief, and Economic Security Act (the “CARES Act”), an employer who received a PPP loan could not claim the employee retention credit. Congress recognized that this left many small employers without wage support during the pandemic, once PPP loan proceeds were exhausted. Ironically, the employers most hurt by the rule were those PPP borrowers who did exactly what the program intended and continued to pay their employees and maintained their workforce. In the Consolidated Appropriations Act, 2021 (the “CAA”), Congress revised the rule retroactively to permit employers who received a PPP loan to claim the retention credit but only with respect to wages (and allocable group health plan expenses) that were not used to obtain forgiveness of a PPP loan.
Unfortunately, in drafting the Notice, the IRS takes a narrow approach to interpreting this rule that will preclude many small businesses from claiming the credit to the extent Congress seems to have intended. Under the PPP, borrowers can obtain full forgiveness of a PPP loan if the loan proceeds were used for certain permissible expenses. Among these expenses are payroll costs, mortgage interest, rent, and utility payments. As originally designed, the maximum loan amount was based on 2.5 months of payroll (subject to a cap) and was required to be expended over an 8-week period to obtain forgiveness. Later, the period to use the funds was expanded to 24 weeks in recognition of the reality that many small businesses had already reduced their workforces by the time PPP loan proceeds reached them. Among the requirements for forgiveness is the obligation to have spent 60% of the loan amount on payroll costs. Payroll costs are similar to, but broader than, qualified wages for small employers. (For example, employer contributions to retirement plans are payroll costs but are not qualified wages.)
By the time the CAA was enacted, many borrowers had already submitted an application for forgiveness. In consultation with lenders and outside advisors, many borrowers sought forgiveness solely on the basis of payroll costs because they were easily documented using quarterly employment tax returns and other materials. This made life simpler for everyone, including the banks—although, under the IRS’s approach in the Notice, it also boxed the employers out of claiming at least a portion of the employee retention credit to which they later became entitled. With the change to allow such employers to claim the retention credit, practitioners quickly identified a problem: Many small businesses sought forgiveness of their PPP loans using payroll costs when they could have had the loan forgiven based on other permissible costs, such as rent and utilities—in which case the would be eligible for a larger credit today.
Unfortunately, the Notice takes an inflexible position that whatever was included on the application for forgiveness (up to the maximum amount of payroll costs required for forgiveness) cannot be considered qualified wages. In contrast, if the employer can demonstrate that the payroll costs included on the application did not include an amount of qualified wages, the retention credit may be claimed with respect to that amount. Had lenders, borrowers, and their advisors known then what they know now, they surely would have made sure to include as few qualified wages as possible on the application for forgiveness. The IRS could have excused the expedient approach used by many PPP borrowers. For example, it could have required the employer to maintain sufficient records and documentation of other permissible expenses that could have been included on a PPP forgiveness application and showing how the employer determined the amount of qualified wages remaining. Would such an approach have made audits of employers who participated in the PPP more difficult for the IRS? Without a doubt, yes. But even with that concern, the IRS should not have frustrated Congress’s intent by issuing guidance that effectively limits the relief Congress intended to provide and that many small businesses still desperately need.