How PPP Loans May Affect ASC 740

Companies that received loans under the Paycheck Protection Program (PPP) are continuing to evaluate how the loans impact accounting and income taxes. Debt forgiveness raises questions as to how to account for the loans, the tax consequences of forgiven loan amounts, and the effect on accounting for income tax.

Accounting for PPP Loans

Out of four different models that may be used to account for PPP loans by business entities, the most prevalent appears to be  the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 470 Debt model, Under this model, loan recipients should account for the loan as debt even if they plan to apply for forgiveness. Also, ASC 835 states that recipients should treat interest as accruing at the effective interest rate over the term of the loan. Lastly, recipients should recognize any forgiven amount as a gain. This includes interest that was accrued but not paid.

Federal Tax Treatment

PPP loan forgiveness is excluded from taxable income. Previously, pursuant to Internal Revenue Service (IRS) Notice 2020-32, expenses that are paid from the loan proceeds are not allowed as a deduction. On December 27, 2020, the Consolidated Appropriations Act (CAA) was signed into law, which reverses existing IRS guidance provided in Notice 2020-32 by allowing taxpayers to fully deduct any business expenses paid with forgiven PPP loan proceeds. The loan forgiveness is still excluded from federal taxable income, while companies can now deduct the related expenses.

Impact on ASC 740

As mentioned above, companies that receive loan forgiveness will recognize a gain upon debt extinguishment. As this income is not taxable for federal tax purpose, companies will have a favorable permanent adjustment to reverse the book income recognized upon forgiveness in their tax provision and tax return. Companies should give careful consideration as to how this impact should be reflected in interim provisions. Given the unusual and infrequent nature of the PPP loan, the tax impact of PPP loan should be treated as a discrete item in the period in which forgiveness occurs. This is particularly important when the amount of forgiveness is large in relation to forecasted income.

If companies have set up any timing differences prior to the passage of the CAA due to the difference between book and tax treatment of the expenses when loan forgiveness occurred and was recorded after the period in which expenses were incurred, those deferred balances should be eliminated with the enactment of the CCA. The shift to expenses being deductible is a change in tax law, and accordingly, should be reflected in a company’s tax provision in the period of enactment (i.e., the period including Dec. 27, 2020).

Example:

• Company is projecting full year income of $1M excluding PPP loan forgiveness income.
• The annual effective tax rate (AETR) is calculated to be 25%.
• YTD pretax book income is $400k excluding PPP income. PPP loan income is $150k.
• Quarterly provision expense is $100k ($400k x 25%), PPP loan income is excluded from taxable income as discussed above.
• Total quarterly provision is $100k, quarterly effective tax rate is 18% ($100k / ($400k + $150k)).

State and Local Income Tax Considerations

While the CAA clarified the treatment of PPP loan forgiveness for federal tax purposes, the tax treatment by the states is less clear. Several states have conformed to the federal treatment of PPP loans, but others still tax the PPP loan forgiveness income by either treating forgiven loan amounts as taxable income, denying deductions for PPP related expenses, or both. Given these differences, companies should continue to monitor changes in state tax legislation to ensure that they treat these tax items properly in the jurisdictions in which they operate.

For more information on the impact of the PPP loan on accounting for income taxes, contact us. We are here to help.

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