Earlier this year, Congress passed the CARES Act to provide an economic stimulus to assist businesses, individuals, and health care providers impacted by the Coronavirus pandemic. The idea behind CARES was to offer businesses incentives with various tax provisions and loan opportunities, including the well publicized “Paycheck Protection Program” (PPP).
Another incentive, which has been available to businesses for nearly 40 years, is the “Credit for Increasing Research Activities” (“Research Credit” or R&D Credit). Many businesses do take advantage of this incentive, and while it has gone through several changes and enhancements over the years, there were no changes to the Research Credit as part of any stimulus legislation related to the pandemic.
There could be an opportunity for businesses that obtained a PPP loan and also expect to claim the Research Credit this year. This Sikich Tax Alert highlights the intersection of the PPP loan and the Research Credit and how to get the most benefit out of both.
As PPP loans were designed to provide working capital and liquidity to employers impacted by the Coronavirus, companies needed to use the PPP loans to pay certain necessary expenses, primarily payroll. For the loan to be forgiven, the companies, as borrowers, will need to file an application for PPP loan forgiveness and document how their loan proceeds were spent.
The Small Business Administration (SBA) and the IRS have issued guidance on the PPP loan process and the tax provisions of CARES to assist borrowers, lenders, and advisors. In addition, Congress made changes to address various issues and concerns with the PPP loan program, including the following:
The idea is for a company to accomplish two goals: (1) have their PPP loan fully forgiven; and (2) at the same time, maximize the R&D credit for 2020. With the expanded 24-week period and the ability to have 40% of the qualifying costs as non-payroll, many companies may generate qualifying costs that greatly exceed the amount of their PPP loan. As it is likely to have excess qualifying costs for PPP loan forgiveness, a company should be able to have its entire loan forgiven—but the key will be for the company to allocate the costs in such a way as not to reduce the impact on its R&D credit. If possible, any payroll costs that would be includible as a QRE should not be reported on the Loan Forgiveness Application.
Therefore, companies should look at several strategies to achieve these goals.
The following other points should be noted in this situation:
The best approach at this point is for borrowers to allocate the PPP loan proceeds for non-payroll costs up to the lesser of: (1) their actual non-payroll costs; or (2) 40% of the total loan proceeds. Next, for the remaining 60%+ of the payroll costs, assign as much of this remainder to non-QRE costs. The final Research Credit calculations can then be performed when the company files its tax return (including an extension of time to file). As a result, we would suggest businesses refrain from filing early to see if any additional IRS guidance is issued.
This example further illustrates the strategy of what payroll costs to treat as being forgiven.
Harvest Company (“Harvest”) makes high-tech pumpkin and fall decorations. The Company applied for and received a PPP Loan of $1,000,000. Using a 24-week covered period, Harvest incurred $1,800,000 of expenses eligible for loan forgiveness as follows:
Harvest applies for its PPP loan forgiveness using the following amounts:
Harvest submitted total qualifying costs of $1,000,000 and received full PPP loan forgiveness of 1,000,000. Thus, no taxable income is recognized to Harvest on the forgiveness of this $1,000,000 in PPP loan. Further, Harvest is not able to deduct the corresponding $1,000,000 of expenses, with $400,000 being assigned to the non-payroll expenses (interest, rent, and utilities), and $600,000 assigned to payroll costs that are non-QRE-related.
Harvest also takes advantage of the Research Credit every year. Over the prior three years, it incurred average annual QREs of $3,000,000. It also expects to incur $3,000,000 of QRE expenses in 2020, which includes the above $400,000 of expenses that were eligible costs for PPP loan forgiveness but not submitted as part of the loan forgiveness application.
In this situation, Harvest would be entitled to a Research Credit calculated as follows using the Alternative Simplified Method (“ASC”):
If, instead, Harvest had included all $400,000 of its qualifying payroll costs that were QRE-related in its PPP loan forgiveness application, these costs would still have resulted in the full PPP loan forgiveness of $1,000,000. The 2020 QRE costs would, however, have been reduced from $3,000,000 to $2,600,000. Thus, Harvest’s 2020 Research Credit calculation would have been determined as follows:
By assigning the full 40% of the non-payroll costs and the non-QRE payroll costs for its PPP loan forgiveness application, Harvest is able to: (1) receive full loan forgiveness on its PPP loan of $1,000,000; and (2) receive the maximum R&D Credit of $210,000. Had Harvest not allocated the QRE payroll costs in this manner, Harvest could still have received full loan forgiveness of $1,000,000 but would have seen its Research Credit cut by $56,000 from $210,000 to $154,000.
The PPP loan has provided much needed funding for many businesses in 2020 as they navigate the many challenges presented by the pandemic. However, the PPP loan also introduced many questions and uncertainties for borrowers and lenders. Despite these challenges, the loan forgiveness presents an incentive for borrowers, and if a borrower also claims a Research Credit, they might be able use both. Please contact your Sikich advisor with any questions or for help analyzing your tax situation.
This publication contains general information only and Sikich is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or any other professional advice or services. This publication is not a substitute for such professional advice or services, nor should you use it as a basis for any decision, action or omission that may affect you or your business. Before making any decision, taking any action or omitting an action that may affect you or your business, you should consult a qualified professional advisor. In addition, this publication may contain certain content generated by an artificial intelligence (AI) language model. You acknowledge that Sikich shall not be responsible for any loss sustained by you or any person who relies on this publication.