Wednesday, May 6, 2020
On April 1, https://lawprofessors.typepad.com/agriculturallaw/2020/04/disasteremergency-legislation-summary-of-provisions-related-to-loan-relief-small-business-and-bankruptcy.htmlI published a detailed article on this blog concerning the CARES Act and, in particular, the Paycheck Protection Program (PPP). The PPP is an extension of the existing Small Business Administration (SBA) 7(a) loan program for a “qualified small business” with many of the existing restrictions on 7(a) loans waived for a set timeframe including guarantee and collateral requirements and the requirement that the borrower cannot find credit elsewhere. The purpose of the program is to support small businesses and help support their payroll during the coronavirus situation. In addition, a small business loan borrower is eligible for loan forgiveness on existing SBA 7(a) loans.
Over the past six weeks, the U.S. Treasury Department and the SBA have been issuing guidance concerning various aspects of the CARES Act, including the PPP. In spite of all of the guidance, questions remain for farmers and ranchers.
Lingering questions and issues surrounding the PPP – it’s the topic of today’s post.
Is Ag Eligible?
After some initial questions concerning whether farming and ranching businesses qualified for the PPP, the SBA issued an Interim Final Rule and an FAQ clarifying that ag businesses are eligible upon satisfying certain requirements. Unfortunately, while ag businesses are eligible apparently some lenders were apparently advising farmers that participation in the PPP would either reduce their USDA farm subsidies or eliminate their eligibility for them. That is not true. There is no basis for reaching that conclusion based on the statutory language. Some lenders were also apparently informing farmers that they wouldn’t be eligible for the ag part of the CARES Act Food Assistance Program. Again, there is no basis for that conclusion.
Other Areas of Concern
Loss on Schedule F? While the SBA has clarified that Schedule F income can be used for computing loan eligibility, the SBA has taken the position that a loss on line 34 of Schedule F disqualifies the farm/ranch taxpayer from loan eligibility based on earnings. Thus, such a farmer can only qualify for a PPP loan based on employee payroll costs (if any). That’s a harsh rule as applied to farmers and ranchers – particularly smaller operations that don’t have employees. Income that shows up on a form other than Schedule F doesn’t count toward for purposes of loan computation. While this could be changed in the future, the present position of the SBA is that eligible income is only that subject to self-employment tax.
Passive rental income. As noted above, the SBA position is that loan eligibility is tied to self-employment earnings. Apparently, that position means that rental income that is not reported on Schedule F fails to qualify (such as that reported on either Schedule E or on Form 4835).
Partnerships. For a partnership, PPP loan filing is at the partnership level. Thus, a partner is precluded receiving a loan at the partner level. A partnership can count all employee payroll costs for loan computational purposes and all self-employment income of partners reported on line 14a of Schedule K/K-1. That amount is then reduced by any I.R.C. §179 expense deduction claimed; unreimbursed partnership expenses claimed, and depletion claimed on oil and gas properties. The result is then multiplied by 92.35% to arrive at net self-employment earnings. If the final amount exceeds $100,000, it is to be reduced to $100,000. Whether that same computational approach applies to a Schedule F farmer (or Schedule C filer) is unclear. Relatedly, it’s unclear whether the ordinary income of manager-managed LLCs where self-employment tax is reduced counts toward the PPP loan computations purposes. Likewise, if a taxpayer has an interest in more than one partnership that are treated as self-employed entities, a question remains as to whether each entity can qualify for a loan or whether the $100,000 compensation limit must be allocated among the partnerships. The same lack of clarity applies to LLCs taxed as a partnership.
Commodity wages. In computing eligible wages, S or C corporations are only allowed to use taxable Medicare wages & tips from line 5c of Form 941 (Employer’s Quarterly Federal Tax Return). These wages are subject to FICA and Medicare taxes. If eligible wages must be subject to FICA and Medicare tax, agricultural commodity wages will not be eligible. Thus, the question is whether Form 943 (Employer’s Annual Federal Tax Return for Agricultural Employees) filers are to be treated as Form 941 filers.
Payroll costs. Certain sectors of the agricultural economy hire a significant amount of H2A workers. Recent guidance of the SBA and the Treasury indicate that wages paid to an H2A worker can count as eligible “payroll costs” if the worker satisfies the “principle place of residence” test under the Internal Revenue Code – at least 183 days present in the U.S. during the year. That would seem to mean that H2A workers in the U.S. year-round will also qualify. What’s not clear is whether wages paid to H2A workers count even if ultimately the worker is to return to the worker’s home country.
Loan forgiveness. As I noted in my article of April 1, https://lawprofessors.typepad.com/agriculturallaw/2020/04/disasteremergency-legislation-summary-of-provisions-related-to-loan-relief-small-business-and-bankruptcy.html loan proceeds that are forgiven and are not included in the recipient’s income do not give rise to deductible expenses by virtue of I.R.C. §265. On April 30, the IRS agreed. I.R.S. Notice 2020-32. Now certain members of the Congress are putting pressure on the I.R.S. to change its position. Another area needing clarification is how the amount of the loan that is forgiven is to be computed for a sole proprietor or self-employed taxpayer – is it based on eight weeks of self-employment income in 2019 plus qualified expenses, or is it simply limited to eight weeks of self-employment income? Is employer compensation counted as “wages”?
Bankruptcy. Can a debtor in reorganization bankruptcy apply for a PPP loan and receive funds upon satisfying the requirements for a loan? The answer, at least according to one bankruptcy court, is “yes.” In re Springfield Hospital, Inc., No. 19-10283, 2020 Bankr. LEXIS 1205 (Bankr. D. Vt. May 4, 2020). This is an important development for small businesses and farming operations.
The uncertainties surrounding the PPP are largely a result of the legislation being crafted in a rush without numerous hearings and vetting of the statutory language and thought being given to related impacts of the statutory provisions. Since enactment of the CARES Act in late March, guidance from the SBA and the Treasury/IRS has largely been of the non-substantial authority type. It’s not binding on the IRS or taxpayers. Unless the unclear aspects of the PPP are clarified substantially, it could mean that litigation could arise and be ongoing into the future.