Paycheck Protection Debt Forgiveness and SBA EIDL Grants. What should we do?
If you’ve received either the SBA EIDL grant or Paycheck Protection (PPP) debt forgiveness, you may be wondering about the correct accounting treatment of these funds. Like the stimulus payments, any portion of debt forgiveness received under the PPP CARES Act is tax-free. The EIDL grant on the other hand is taxable income according to the 2013 IRS Guidance on "Casualty Loss with an SBA Loan".
Accounting for government grants or forgiveness generally depends on the nature and conditions of the grant. Under the CARES Act guidelines, Paycheck Protection must be used to retain employees or cover certain qualifying expenses. A borrower may then apply for debt forgiveness within 8-weeks of loan receipt. All or a portion of the loan is guaranteed to be forgiven if used for the authorized purpose.
The SBA EIDL may be used as working-capital which means these funds can be used to pay employees, cover cost of goods, invest in machinery or reduce company debt. The catch is a borrower may not use both programs solely to pay employees.
If you’ve used the SBA EIDL grant to pay employees or pay your vendors, then the grant must be included in your gross income on your Profit and Loss. You may record this as a subcategory called “Other Income – EIDL” to create a segregation.
If you decide to use the EIDL SBA grant to purchase new equipment, then the grant could be classified as deferred income on the balance sheet and recognized to the profit and loss in the same period as your depreciation expense.
The forgivable portion of the, Paycheck Protection loan should be treated differently. The CARES act in Section 1102 states: “Taxability.—For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.”
Based on Section 1102 guidance, the forgivable portion of the Paycheck Protection Program loan could be classified on the Profit and Loss as Tax-Free Income. Or you could record this as an addition to Equity on the Balance Sheet.
The benefit of this debt-forgiveness are multiple, it provides the needed funding to retain employees and it reduces your taxable income. Adding the debt forgiveness to Equity will increase Stockholder's Basis which allows you to claim net losses on your tax return if you're a Partnership or S-corp.
Proper accounting treatment of these unusual funding source is important so that you don’t misrepresent taxable income. You also don’t wouldn’t want to violate any covenants or regulations which may prohibit you from further accessing government funding.
If there are any updates to the SBA Grant guidelines, we will update this blog.