Look Before You Transfer: Is there a PPP Loan?

by Vanessa L. Kanaga, Esq., President and Director of Content Development, InterActive Legal

An Additional Consideration for Those Advising Business Owners on Lifetime Gifts¹

As we near the end of 2020, many estate planners are doubling their efforts to assist clients with making lifetime gifts to take advantage of the current estate and gift tax exemption ($11.58 million) before its possible reduction following changes in the federal government next year.  As any estate planner will tell you, there are always a number of factors to consider in determining whether lifetime gifting is an appropriate strategy and, if so, what form the gifts should take.  In addition to the "normal" concerns, many business owners looking to make gifts of their business interests in the near future must consider an additional factor:  the possible effects of Paycheck Protection Program (PPP) loans. 

 

Authorized by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, PPP loans were intended to provide economic relief to businesses and employees facing threats to their revenue streams due to the pandemic.  The loans were processed by private lenders (the "PPP Lenders") and the funds were disbursed by the Small Business Administration (SBA), which runs the program.  Loan recipients that used loan proceeds on eligible expenses (primarily wages and other payroll expenses) may apply to have the loan forgiven.  Any portion of a PPP loan that is not forgiven must be repaid at a rate of 1% interest over a period of two or five years (depending on the date the loan was approved).² 

 

It goes without saying that 2020 was an unprecedented year.  Given the unique economic crisis related to the pandemic, many businesses that were successful prior to the pandemic suddenly faced economic uncertainty.  A number of previously thriving businesses applied for and received PPP loans in order to sustain their workforce and operations.  Over 5 million loans were approved.³   Accordingly, it stands to reason that many estate planners currently are working with clients who own interests in businesses that received PPP loan funding, and who may wish to transfer those interests as part of a gifting strategy. 

 

When advising owners of businesses that may have been eligible for a PPP loan, estate planners should ask the client (1) whether the business received a PPP loan, and (2) whether any portion of the loan is outstanding (i.e., has not been forgiven or repaid).  If the business has an outstanding PPP loan, the estate planner will need to be aware, and make the client aware, of issues potentially affecting the client's planning.  These include the following:

1. Restrictions on Change in Ownership

On October 2, the SBA issued Procedural Notice Control No. 5000-20057 setting forth "required procedures for changes of ownership of an entity that has received [PPP] funds (a 'PPP borrower')."  That notice provides:

"Prior to the closing of any change of ownership transaction, the PPP borrower must notify the PPP Lender in writing of the contemplated transaction and provide the PPP Lender with a copy of the proposed agreements or other documents that would effectuate the proposed transaction."

A "change of ownership" is defined as (1) the sale or other transfer of at least 20% of the common stock or other ownership interest of the PPP borrower, whether in one or more transactions, (2) a sale or other transfer of at least 50% of the PPP borrower's assets, as measured by fair market value, again whether in one or more transactions, or (3) merger of a PPP borrower with or into another entity.

This is consistent with the terms of the SBA promissory note form made available for use by PPP Lenders (the "SBA Note Form"), which provides that the PPP borrower is in default if it "[r]eorganizes, merges, consolidates, or otherwise changes ownership or business structure without [the PPP] Lender's prior written consent."⁴   However, in addition to requiring the PPP Lender's approval, the notice establishes certain circumstances in which a change of ownership must also be approved by the SBA. 

Estate planners advising clients with ownership interest in PPP borrowers should review the notice and be aware that certain transfers of the client's ownership interest will require approval by the PPP Lender and possibly the SBA.

2. Additional Terms of Default

In addition to the restrictions on changes in ownership referenced above, estate planners should also be aware of the other terms of default under the PPP borrower's promissory note, and consider how those terms of default may affect potential transfers of a client's interest in the PPP borrower.  For example, under the SBA Note Form, the terms of default include the PPP borrower's assignment for the benefit of a creditor, and "any adverse change in financial condition or business operation that [the PPP] Lender believes may materially affect [the PPP borrower's] ability to pay" the promissory note.  Though most lifetime transfers will not trigger these provisions, it is possible that certain transactions could be problematic, depending on the structure.  In addition, PPP Lenders were permitted to use their own form of promissory note, rather than the SBA Note.  Accordingly, it is important to review the terms of the promissory note signed by the PPP borrower when evaluating its potential implications relating to lifetime transfers.

3. Non-Deductibility of Expenses

Although not directly affecting lifetime transfers by owners, it is important to note that PPP borrowers seeking loan forgiveness are not permitted to deduct from income taxes the expenses for which the PPP loan proceeds were used.  In order to be eligible for forgiveness, a majority of the loan proceeds must have been used to cover wages and other eligible payroll costs, many of which are generally deductible expenses for income tax purposes.  The CARES Act provides that any PPP loan amount forgiven is excluded from the PPP borrower's gross income for federal income tax purposes.⁵   In Rev. Rul. 2020-27⁶, the IRS confirmed that any such forgiven loan proceeds (or loan proceeds expected to be forgiven) would be considered tax-exempt income, and any otherwise deductible expenses allocated to the forgiven loan proceeds (or loan proceeds expected to be forgiven) are non-deductible under Section 265(a)(1) of the Code. 

Although many businesses will still choose loan forgiveness, even if it means the expenses attributable to forgiven loan proceeds will be non-deductible, it is important to note the effect that such non-deductibility could have on other tax benefits, such as the qualified business income deduction under Section 199A of the Code, eligibility for which is dependent in part on wages paid during the tax year.  In most cases, the analysis of this issue is best placed in the hands of the business's accountant.  However, estate planners should be aware of this limitation and its potential impact on the business, particularly if the client anticipates transferring the business interest as part of the estate plan.  The estate planner can be a valuable resource to the client by making sure the client is aware of this issue and the need to confer with the business accountant.

 

At all times, estate planners must be aware of the various legal and practical matters affecting their clients' business interests.  In 2020 and 2021, the Paycheck Protection Program will provide an additional factor requiring consideration for certain clients.  As always, estate planners should be prepared to discuss the potential impact of this development with their clients and the clients' accountants and other professional advisors, as appropriate.

 

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¹  Thank you to Abigail O'Connor of O'Connor Law PLLC in Anchorage, Alaska, for suggesting this topic, and for her helpful comments.
² For additional information, see Section 1102 of the CARES Act, Pub. L. § 116-136 (Mar. 27, 2020); see also https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program#section-header-2. 
³ https://home.treasury.gov/system/files/136/SBA-Paycheck-Protection-Program-Loan-Report-Round2.pdf.

⁴ SBA Form 147 (06/03/02) Version 4.1, paragraph 4(L).
⁵ See Pub. L. § 116-136, Section 1106(i). 
⁶ Released in advance on November 18, 2020.  Rev. Rul. 2020-27 confirms earlier guidance issues in IRS Notice 2020-32, 2020-21 IRB 837 (May 18, 2020).

 

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Meet Vanessa L. Kanaga, Esq.

President and Director of Content Development

Vanessa Kanaga joined InterActive Legal in 2013, and serves as President and Director of Content Development. In her role, Vanessa oversees the development of InterActive Legal program content, in addition to working with CEO, Michael L. Graham, to guide the company in its future direction, and manage day-to-day operations.

Vanessa received her J.D. from Cornell Law School, Magna Cum Laude, in 2006, and holds a B.A. in Philosophy from Wichita State University, with a minor in Music, as well as an Advanced Professional Certificate from New York University School of Law. Following law school, Vanessa practiced in New York for several years, at Milbank, Tweed, Hadley & McCloy, LLP, and then Moses & Singer, LLP. In 2012, she returned to her home town of Wichita, Kansas, where she was an associate attorney in the estate planning and probate practice group at Hinkle Law Firm, LLC, before joining InterActive Legal.