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Rene Schaefer
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COVID-19 has upended our daily lives, and many companies are searching for ways to aid their employees through the ongoing challenges of the moment. Thankfully, there is a little-known tax provision (IRC Section 139) which provides for disaster relief payments that can help employers support their workers.

In a federally declared disaster, IRC Section 139 allows employers to provide employees with disaster assistance on a tax-free basis to the employee, and the employer receives a tax deduction as well.

About the Provision

On March 13, 2020, President Trump issued an emergency declaration under the Robert T. Stafford Disaster Relief and Emergency Assistance Act in response to the ongoing COVID-19 pandemic.

As a result of that federal disaster declaration, employers may now reimburse or pay their employees for reasonable and necessary personal, family, living, or funeral expenses incurred. Any COVID-19 related payments made to employees under this provision are federally tax-free to the employee and fully deductible to the employer. These payments do not include any payments made for compensation, including paid sick or family medical leave, or expenses otherwise reimbursed by insurance. These payments are not included on a Form W-2 or 1099 and are not subject to federal income or payroll tax withholding.

There is no requirement that the employer have a written plan, but it is strongly recommended. The plan might include who is eligible, what types of expenses qualify, thresholds by type of expense and/or by employee, any documentation needed, how to request the payment, and how the payment will be made. There is no limit on the amount or frequency of the payments.

There is also no requirement the employee provide documentation to support the expenses claimed, but it is strongly recommended the employee provide paperwork or a signed statement verifying the expense.

Generally, states follow the federal treatment for qualified disaster relief payments. Employers may want to confirm their respective state follows the federal rules for income tax and unemployment insurance tax purposes.

Examples of COVID-19 Related Expenses

Some examples of COVID-19 related expenses include unreimbursed medical costs, over-the-counter medications, funeral costs, increased childcare/tutoring (due to school closings, remote learning or home schooling), working from home expenses (computers, monitors, scanners, cell phone, supplies, increased utilities/internet, etc.), sanitation supplies, or increased transportation costs (from lack of access to public transportation) as a result of COVID-19.

Conclusion

In these uncertain and stressful times, the tax-free disaster relief payments available through IRC Section 139 can be a great way to help your workforce, as well as assist the company with operations, efficiency, and garnering employee goodwill/support.

Please contact your Clark Nuber professional or Rene Schaefer with any questions.

© Clark Nuber PS and Developing News, 2020. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Developing News with appropriate and specific direction to the original content.

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Leveraging COVID-19 for Family Business Succession Planning

For many businesses, COVID-19’s fallout has resulted in temporary shutdowns, furloughed workers, renegotiation of bank loans, and cloudy, diminished revenue backlogs. Yet despite these obstacles, there’s a real opportunity for family business leaders to take advantage of a reduced company valuation. Under the right circumstances, a lower valuation can actually enhance the ability of a senior generation to leverage lifetime gift tax exclusions or to sell at reduced values to other family members and subsequent generations.

Calculating Business Valuations

The primary factors impacting valuation are far-ranging, but they typically include:
  • Multiyear cash flow projections for the next 5-10 years
  • Debt levels, including the timing and flexibility of timing for loan maturities. Might the current loans be in “special credits” due to non-compliance of debt covenants agreed to six or nine months ago?
  • Industry trends, which in the current pandemic landscape might include long-term work-from-home implications, the shift to online commerce, and government travel restrictions
  • Entrance to the market of new competitors which may affect future growth prospects
  • Management and staff talent levels
By analyzing the above factors, a valuation firm can then crystalize the two critical factors affecting company valuation — risk and growth expectations. Obviously the higher the risk profile and lower the growth expectations, the lower the value.

Next Steps

Now may be the time for many family businesses to reach out to well established local valuation firms and seriously discuss the degree of COVID-19 impacted valuations. The results of these conversations might very well enhance and leverage intrafamily gifting, sale transactions, or other family wealth transfer techniques. Lastly, the presidential election on November 3rd might also usher in a diminished or reduced ability to transfer family businesses to future generations. The timing of the current pandemic, combined with the upcoming uncertainty regarding the presidential election, makes this an opportune time for a refocus on potential family business transfers to the next generation. If you have any questions regarding family wealth transfer strategies, contact a Clark Nuber professional. © Clark Nuber PS, 2020. All Rights Reserved

Do the New Mortgage Interest Rules Affect You?

This article was originally published on 7/26/2018 and has been updated to provide further clarity. The Tax Cuts and Jobs Act (TCJA) has significantly changed the tax deduction mortgage interest rules. Though the mortgage interest deduction is not gone, there is confusion about the new rules and who they apply to. If you can still itemize deductions under the TCJA, you need to be aware of these new tax provisions.

What mortgage interest is deductible?

In the past, mortgage interest was deductible for home acquisition debt up to $1 million or less ($500,000 for married filing separate) on one or two homes plus home equity interest debt of up to $100,000 that was secured by the home. Under TCJA, mortgage interest is deductible if the home acquisition debt is $750,000 or less ($375,000 for married filing separate) on one or two homes for 2018 through 2025. Debt incurred on or before December 15, 2017 is grandfathered in under the old rules for home acquisition debt of $1 million or less. Debt will also be grandfathered in if there was a written binding contract before December 15, 2017 to close on the purchase of a principal residence before January 1, 2018, and purchase the residence before April 1, 2018. Home equity interest is generally no longer deductible for 2018 through 2025. There’s an exception to deduct home equity interest if the proceeds were used to buy, build or substantially improve the taxpayer’s home that secures the loan. It is still subject to the overall debt limits. Documentation and tracing will be important to determine the amount of deductible home equity interest.

How is refinancing treated?

For home acquisition debt to continue to be grandfathered under the old rules of $1 million, the refinanced debt can only be for the amount of the old mortgage debt and for the remaining original debt term. There can be no cash taken out – even to cover closing costs. If the refinanced term is extended, the grandfathered portion ($1 million) only applies for the remaining years of the original loan term. Special rules apply if the original mortgage debt is not amortized over the life of the loan (i.e., has a balloon payment at the end). For example: A home acquisition debt was taken out in 2010 for $1 million for 30 years and the outstanding balance of $850,000 is refinanced in 2018. If the refinanced debt term is 30 years, the $1 million limitation applies for the remaining 22 years. After 2025, the old rules will apply – mortgage interest expense will be deductible for the home acquisition debt up to $1 million and home equity interest debt up to $100,000. The new mortgage interest rules will generally apply to new home acquisition debt after December 15, 2017. These rules may affect the Seattle/Bellevue areas more than other areas, since the average home price is well over $750,000. It is important to know the rules before you purchase your next home or refinance your mortgage to avoid any surprises and higher taxes than expected. Please contact your Clark Nuber professional or Rene Schaefer to understand this new tax provision and how it may affect you. © Clark Nuber PS, 2018. All Rights Reserved  

Roadmap to Paycheck Protection Program Loan Forgiveness – Part II: Eligible Expenses

This is the second post in a series of articles on Paycheck Protection Program loan forgiveness. Part I: The Covered Period can be accessed here. Parts III and IV will be published in the coming weeks. Many Paycheck Protection Program (PPP) borrowers have now started their loan forgiveness calculations and are questioning which expenses are eligible for forgiveness. This article will walk through the four types of eligible expenses and address some of the common questions. As mentioned in our previous article on PPP loans, achieving maximum loan forgiveness requires the following:
  1. Utilize at least 60% of the proceeds for payroll costs during the covered period (previously the threshold was 75%, but the Paycheck Protection Program Flexibility Act (PPPFA) reduced it to 60%);
  2. Entire loan proceeds are spent on eligible expenses – payroll costs, interest on loans, rental payments, and utility costs;
  3. Restore the number of full-time equivalent employees by the end of the covered period; and
  4. Restore wages to employees by the end of the covered period.

Eligible Expenses

The CARES Act specifies four categories of expenses for which the PPP loan proceeds may be used: payroll costs, mortgage interest, rent, and utilities. To be eligible for maximum loan forgiveness, at least 60% of the loan proceeds must be spent on payroll costs. If less than 60% of the proceeds are spent on this amount, the amount of forgiveness is reduced prorata.

Payroll Costs

When calculating compensation costs, remember to include an employee’s gross wages, bonuses and hazard pay, commissions, and tips. Payments under vacation plans, parental leave, and medical or sick leave are also included. Additionally, payments for separation or dismissal are also eligible payroll costs. Payroll taxes paid by the employer are not considered eligible payroll costs for the loan forgiveness process. For independent contractors or sole proprietors, payroll costs only include wages, commissions, income, or net earnings from self-employment, or similar compensation. Note that cash compensation payments are capped at $100,000 per employee on an annual basis. Therefore, if an employee earns more than $1,923 per week ($100,000 / 52 weeks), the weekly compensation over that amount cannot count towards payroll costs for loan forgiveness purposes. In other words, a borrower using an eight-week covered period is limited to $15,385 per employee. A borrower with a 24-week covered period is limited to $46,154 per employee. Special rules exist for owner-employees, self-employed individuals, and general partners. Compensation for those individuals during a 24-week covered period is capped at $20,833 (2.5/12 x $100,000). Non-cash compensation payments are not subject to the employee wage cap. This includes payments for group healthcare coverage premiums, employer contributions to a defined-benefit or defined-contribution retirement plan, and payments of state and local taxes assessed on compensation of employees, including unemployment taxes. Note that healthcare benefits paid by employees, such as the employee share of healthcare premiums, are not an eligible expense. It makes no difference if the amounts are paid using pre- or post-tax dollars based on the recent guidance issued by the SBA on August 4. Payments paid for fringe benefits (except for health insurance) and other ancillary benefits, such as disability insurance, gym memberships, and employer-paid group life insurance, are also not included in payroll costs. Currently, there is no requirement that a borrower must only include the payroll costs originally identified on the borrower’s loan application when applying for forgiveness. The SBA has issued additional guidance over the past few months that expands the definition of payroll costs, including items such as bonuses, hazard pay, and minister housing allowances. Absent further guidance from the SBA, borrowers may use the most recent guidance in determining eligible payroll costs for the loan forgiveness application. It is unclear at this time how payments to non-group healthcare plans are treated. This includes employer payments to Health Savings Accounts and reimbursement arrangements for an individual with healthcare coverage that is not part of a group plan. Last, remember there is no double dipping on payroll costs. If the borrower is claiming a credit under the Families First Coronavirus Response Act (FFCRA) for sick and family leave wages, these wage costs cannot be used towards the PPP loan forgiveness costs.

Mortgage Interest

Interest on mortgage obligations during the covered period is considered an eligible expense for loan forgiveness. The loan itself must have been in place before February 15, 2020. If the borrower obtained other financing during its covered period, the interest paid on those loans are not eligible expenses. The mortgage may be for real or personal property. Therefore, interest paid or incurred on office equipment, company vehicles, and machinery are all eligible costs. Advance payments of interest are not eligible for loan forgiveness. Additionally, principal payments on mortgage obligations are not eligible expenses. The additional guidance provided by the SBA in August clarified an important question for many borrowers. Previously, it was unclear whether interest on a refinanced mortgage counted as an eligible expense. Per the additional guidance, if the loan existed prior to February 15, 2020 and is refinanced on or after February 15, 2020, the interest payments on the refinanced mortgage are considered eligible expenses if paid or incurred during the covered period. To date, no guidance has been provided on construction loans and whether the interest payments are an eligible expense.

Rent

Rent or lease payments for leases in place prior to February 15, 2020 are eligible expenses. The rent may be for real or personal property. Additionally, if a lease existed prior to February 15, 2020, but it expires on or after that date, then payments for rent under the renewed lease are eligible expenses. The SBA has not specifically indicated whether prepaid rent or rent paid in arrears are eligible expenses. However, guidance has been issued on advance mortgage payments that indicate these are not eligible expenses. It seems reasonable that advance rental payments may have the same treatment. Back payments of rent, however, are eligible for loan forgiveness if they are paid within the borrower’s covered period. It is unclear at this time whether “rent” is defined as just the property itself or if it also includes other costs associated with rent, such as property insurance or management fees that may be billed by a landlord. Utility payments billed by a landlord are likely includible, since utilities costs themselves are expenses eligible for forgiveness. For borrowers that sublease their space to others, only the rent payment attributable to the space directly used by the borrower is eligible for loan forgiveness. For example, if a borrower pays $10,000 per month for office space, but they sublease a portion to a third party for $2,000 per month, only $8,000 of the rent payment is an eligible expense for loan forgiveness purposes. The SBA has provided no guidance on what a borrower should do when a lease modification occurs on February 15 or later. The guidance provided in August only addresses a lease that expires and is renewed during the covered period. As borrowers struggle with cash flow, many are negotiating new leases with their landlords. It is not clear whether these lease modifications are considered an extension of the original contract or if they give rise to a new agreement.

Utilities

Utility services in place before February 15, 2020 are qualified expenses. This includes electricity, gas, water, telephone, and internet access. The SBA also includes “transportation” as a utility cost, but no definition currently exists for this term. It is unclear if this would include gas for vehicles or mileage reimbursements. The SBA has not addressed whether costs for garbage collection are included in the definition of utilities. Additionally, it is unclear whether cell phone stipends for employee-owned devices or allowances for supporting remote work environments are an eligible cost.

Paid Versus Incurred

When the CARES Act passed, there were many questions on whether expenses must be incurred or paid to qualify for maximum forgiveness. Through additional guidance from the SBA, it is now clear that both payroll and non-payroll costs, either incurred or paid during the covered period, are eligible expenses. The allowance for expenses incurred (accrual basis) as well as paid (cash basis) essentially expands the period which a borrower can determine its eligible expenses.
  • Example – paid during covered period but incurred cost before covered period starts: Borrower X receives its loan proceeds on Thursday, April 30, marking the beginning of its covered period. The borrower pays its employees on the 1st and 15th of each month. It cuts payroll on May 1 for wages earned April 16 to April 30. Even though the wage costs were incurred before its covered period began, Borrower X may still treat the entire wage payment on May 1 as a qualifying expense since it was paid within the covered period. 
When a cost is incurred during the covered period but paid after the covered period ends, it is only eligible for forgiveness if paid on or before the next regular billing date or payroll cycle.
  • Example – incurred cost during covered period but paid after covered period ends: Borrower X’s covered period ends on Wednesday, June 24. Its next regularly scheduled payroll is July 1 for wages earned from June 16 to June 30. Since the costs are for wages incurred during the covered period, and payment is made on the next regular payroll cycle, Borrower X may treat the portion of wages through June 24 as an eligible expense. 
In these examples, Borrower X can use 10 weeks of payroll costs in its loan forgiveness calculation, even though its covered period is only eight weeks (April 16 – June 24). This is because both paid or incurred costs are considered eligible expenses.

Alternative Payroll Period for Compensation

To simplify things, the SBA allows for an alternative payroll period when determining wages eligible for forgiveness. The SBA recognizes that payroll cycles don’t always line up nicely with the covered period. Thus, for wages only, a different period may be used that lines up with the borrower’s payroll cycle. This alternative payroll period is only available for borrowers with payroll cycles on a bi-weekly or more frequent basis.
  • Example: Borrower Y’s eight-week covered period begins on Thursday, April 30 and ends on Wednesday, June 24. It issues payroll each Friday. Rather than track which payroll periods are within its covered period, Borrower Y can use an alternative eight-week payroll period for its wages – Friday, May 1 to Thursday, June 25. For payroll costs incurred during this alternative covered period but paid after the end of the alternative covered period, these payroll costs will qualify, assuming they are paid on Friday, June 26 (the next regularly scheduled payroll cycle after the end of the covered period). 
Under this scenario, Borrower Y essentially utilizes nine weeks of payroll costs. While the alternative payroll period makes things easier, borrowers may not want to use it as it may result in less allocable payroll costs. However, pay close attention to the staffing levels during the covered period. If staff has been laid off, and the borrower reinstates them shortly after the PPP loan proceeds are received, the alternative payroll covered period may yield a higher staff utilization percentage. As a reminder, the staff utilization percentage is key when determining maximum loan forgiveness. Our next article in this series will discuss this calculation in more detail. Borrowers should run the calculation both ways when working through their loan forgiveness application to determine which covered period is optimal for their situation. If you have questions as you navigate the loan forgiveness process, please reach out to your advisor at Clark Nuber for up to date information on the latest rules surrounding the program. Click here to access Part I of this ongoing series on PPP loan forgiveness. © Clark Nuber PS, 2020. All Rights Reserved

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