*The original article published on May 28, 2020 was updated on June 8 and June 26, 2020 in accordance with the release of IFR #20.
The U.S. Small Business Administration (SBA) originally published two Interim Final Rules (IFRs) on May 22, 2020 - IFRs #14 and #15. The first focused on the SBA’s Paycheck Protection Program (PPP) created by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) loan forgiveness requirements; the second focused on the SBA’s PPP audit procedures, lender responsibilities, processing fees, and guarantees.
Subsequent to the enactment of IFRs #14 and #15, the Paycheck Protection Flexibility Act of 2020 (PPPF Act) was signed into law on June 5, 2020 altering the CARES Act that governs PPP loans. The PPPF Act changed multiple aspects of IFRs #14 and #15, including extending the eight-week forgiveness period to 24 weeks, decreasing the 75% requirement issued by the SBA and Department of Treasury to 60%, extending the deadline to rehire workers from June 30, 2020 to Dec. 31, 2020, and providing for a few additional changes that benefit borrowers.
Following the passage of the PPPF Act, (1) on June 16, 2020, the SBA published an updated version of its loan forgiveness application and a new, shorter version of its forgiveness applications labeled Form 3508EZ, and (2), on July 23, 2020, the SBA published IFR #20, which implements a number of the PPPF Act changes and amended certain provisions of IFRs #14 and #15. This article summarizes IFRs #14 and #15, as updated and amended by the new loan forgiveness applications and IFR #20. See SBA Part Fifteen for additional information on changes to the CARES Act that governs PPP loans as a result of the PPPF Act.
Loan Forgiveness Requirements
IFR #14 reiterated some of the information found within the loan forgiveness application, as well as codified into rule some of the program's leniency found within the application that previously had no basis in law. Some highlights are: (a) bonus payments and hazard pay may be paid with PPP funds and are forgivable if made within the forgiveness period (whether eight or 24 weeks as applicable to the borrower), (b) eligible non-payroll expenses that are also forgivable, such as rent and utilities, can cover more than the forgiveness period, (c) a requirement that employers notify the state unemployment insurance office pertaining to an employee that refuses an offer to be rehired for the same position s/he previously held within 30 days of such rejection, and (d) clarification that the salary reduction provision only applies when it is not attributable to the full-time equivalent (FTE) reduction.
Employers can give bonuses, or increase wages for hazard pay, in order to maximize the amount of loan forgiveness they seek. However, there are a few caveats: (a) the existing $100,000 annualized wage limitation is still applies, meaning no single employee can earn more than $15,385 during the eight-week period or $46,154 during the 24-week period (as modified by the PPPF Act), in each case after including any bonus or hazard pay in addition to ordinary compensation. “Owner-employees” are subject to additional potential limits, as discussed further below.
The term “owner-employee” has not been formally defined by the SBA. The concept originated in IFR #3 but only addressed self-employed individuals that are required to file Schedule C with their IRS Form 1040 tax return and partners in a partnership. IFR #14 provided the first reference to “owner-employees” since IFR #3 but provided no additional detail on what employees would be considered a part of this group. The updates to the loan forgiveness application and IFR #20 expanded the scope of the “owner-employee” to include:
- Self-employed individuals that are required to file Schedule C or F with their IRS Form 1040.
- Partners in a partnership.
- Shareholders of an S-corporation that are employed by the corporation.
- Shareholders of a C-corporation that are employed by the corporation.
Guidance has not been provided addressing whether indirect owners, such as employees that own securities of a parent company of the borrower, are included in the category of “owner-employees”.
Additional Limitations Applicable to Owner-Employees
“Owner-employees” are subject to the same $100,000 annualized wage limitation applicable generally to employee compensation eligible for forgiveness; however, “owner-employees” are also subject to additional limitations on the amount eligible for forgiveness:
- All “owner-employees” of a borrower electing or subject to a 24-week forgiveness period have a maximum compensation amount equal to $20,833. “Owner-employees” did not receive the same increase to $46,154 that non-owner employees received as a result of the PPPF Act.
- All “owner-employees” are subject to a maximum compensation limit equal to their 2019 compensation. This may require a borrower to recalculate its forgiveness amount as such a limitation was not previously contemplated for corporate shareholders in the loan application process or expressly contemplated in the original issuance of IFRs #14 and #15.
- Compensation paid to self-employed individuals that are required to file Schedule C or F with their IRS Form 1040 is further limited by the amount of owner compensation replacement, calculated based on his or her 2019 net profit as reflected on Schedule C or F. Such individuals are not permitted to add employer retirement/health contributions on top of their net profit because such contributions are already reflected in the net profit calculation on Schedule C and F.
- Partners in a partnership are also limited by the amount of their 2019 net earnings from self-employment (reduced by Section 179 expense, unreimbursed partnership expenses, and depletion from oil and gas properties) multiplied by 0.9235, and such individuals are also not permitted to add employer retirement/health contributions on top of their net earnings because such contributions are already reflected in the net earning calculation.
- “Owner-employees” of S-corporations are not permitted to add employer health contributions on top of his or her compensation because such contributions are already included within the compensation reflected on such employee’s Form W-2 as income. Employer retirement contributions continue to remain eligible to be added to such individual’s compensation amount. Employer health and retirement contributions made by a C-corporation borrower continue to remain eligible to be added to its employees’ compensation amounts, even employees that are “owner-employees”.
Eligible & Forgivable Non-Payroll Expenses
Borrowers are permitted to include more than the eight-week or 24-week period of forgiveness for eligible non-payroll expenses. Eligible non-payroll expenses, excepting mortgage interest payments, are forgivable if the expense was paid during the eight-week period, 24-week period, or incurred during the covered period and paid on or before the next regular billing date, even if the billing date is after the eight-week or 24-week period concludes.
Employers Must Notify the State Unemployment Insurance Office
Guidance from the SBA is still pending on how an employer is supposed to notify the state unemployment insurance office. The SBA stated it would post this information on its website. What we do know is that the SBA and Department of Treasury (Treasury), within FAQ #40, provided some leniency for an employer to have a headcount reduction, if that reduction was based on an employee declining an employer’s rehire offer. IFR #14 laid out the procedure for an employer to take advantage of this exception and provided an additional new requirement. An employer must meet the following criteria to be eligible for this exception to the FTE loan forgiveness reduction:
- The borrower made a good-faith, written offer to rehire such employee (or, if applicable, restore the reduced hours of such employee) during the covered period or the alternative payroll covered period.
- The offer was for the same salary or wages and same number of hours as earned by such employee in the last pay period prior to the separation or reduction in hours.
- The offer was rejected by such employee.
- The borrower has maintained records documenting the offer and its rejection.
- The borrower informed the applicable state unemployment insurance office of such employee’s rejected offer of reemployment within 30 days of the employee’s rejection of the offer.
Removal of the Double Penalty
Many of businesses have been concerned that if a full-time employee equivalent (FTE) reduction was needed to reduce an employee’s hours during the covered period that it would reduce their forgiveness amount in two ways. The first, because that employee’s average wage may be reduced by more than 25% as compared to the first quarter of this year, and second, because the lower hours would affect its FTE calculation, thereby triggering the FTE reduction. However, IFR #14 clarifies that even if there is a decline in an employee’s average wages, there will not be a salary/wage forgiveness reduction if the decrease is directly related to a reduction in the number of hours worked, but the borrower will suffer the FTE reduction. Borrowers should note that if they choose the 24-week period, but apply for forgiveness prior to that date because they have run out of PPP funds, they must still include the FTE reductions within their forgiveness calculations for the entirety of their covered period, unless the borrower qualifies for one or both of the FTE reduction safe harbors. The salary reduction affecting loan forgiveness is also applicable for the entirety of the 24-week period and there is no salary reduction safe harbor.
IFR #14 also provided for employee departure relief, as noted within the loan forgiveness application; but a concern we have is the use of the word “during.” This seems to limit this relief to employees that: (a) voluntarily resigned, (b) were fired for cause, or (c) voluntarily reduced their hours only during the eight-week period, or alternative payroll covered period. The alternative payroll covered period is discussed in SBA Part 13. This does not account for individuals that fit into one of these categories between April 26 through the start of the eight-week period, or those from the conclusion of the eight-week period through June 30. See SBA Part Fifteen for additional information on changes to loan forgiveness restrictions and permitted exemptions as a result of the PPPF Act.
Audit and Review Procedures
IFR #15 reiterated that the SBA has authority under the CARES Act to audit any PPP loan. The SBA’s audits will focus on (a) the borrower’s eligibility for a PPP loan, including whether the borrower had an adequate basis to make its good faith certification of economic necessity, whether (b) the borrower calculated the loan amount correctly and used the loan proceeds for uses allowed by the CARES Act, and (c) whether a borrower was entitled to loan forgiveness.
The SBA may conduct its review at any time and has advised borrowers to retain PPP documentation for six years after the date the loan is forgiven or repaid in full. Despite the SBA’s recommendation to retain documentation for six years, Taft recommends borrowers retain documentation for 10 years after the date the loan is forgiven or repaid in full given potential actions that could be brought beyond the six-year anniversary of forgiveness or repayment. Additionally, lenders need to comply with applicable record retention requirements imposed by the SBA on authorized lenders and imposed by the applicable federal financial institution regulator.
The SBA’s review will begin with the documentation submitted by the applicable lender to the SBA. The SBA may make additional documentation requests through the lender or send them directly to the borrower. The SBA will consider such supplementary documentation in making its compliance determination.
If the SBA determines that the borrower was ineligible for the PPP loan, it will direct the lender to deny the loan forgiveness application. Additionally, if the SBA determines that the borrower is not eligible for the loan amount or loan forgiveness amount claimed, the SBA will direct the lender to deny the loan forgiveness application in whole or in part. The SBA may also seek repayment of the loan or pursue other available remedies.1
Loan Forgiveness Process – Lender Obligations
For all loan forgiveness applications, the lender must (a) confirm receipt of the borrower’s certifications in the forgiveness application, (b) confirm receipt of the borrower’s documentation substantiating the borrower’s calculation of payroll and non-payroll costs, (c) confirm the borrower’s calculations in the loan forgiveness application, and (d) confirm that the borrower calculated Line 10 on the forgiveness application correctly. The latest version of the loan forgiveness application can be found here.
The SBA emphasized that, although the borrower is responsible for accurately and truthfully making the calculations on the loan forgiveness application, lenders must perform a good-faith review of the borrower’s calculations. This good-faith review will vary depending on the information submitted by the borrower. For example, a lender would not have to review as closely calculations based on payroll information provided by a third-party payroll provider, like ADP, as it would calculations based on payroll information generated internally by the borrower. If a lender identifies errors, it should work with the borrower to remedy them.
Lenders must make decisions with respect to forgiveness applications no later than 60 days after receipt of the application. The SBA grants lenders discretion to approve the application (in whole or in part), deny the application, or deny the application without prejudice. A denial without prejudice allows the borrower to resubmit2 the forgiveness application with modified calculations and/or additional supporting documentation.
In communicating its decision on a forgiveness application to the SBA, lenders must include:
- The PPP loan forgiveness application.
- The Schedule A Worksheet to the PPP loan forgiveness application.
- Confirmation that the information provided accurately reflects the lender’s records with respect to the loan.
- Confirmation that the lender made its decision in accordance with the IFR.
- A request for payment from the SBA for the portion of the loan the lender approved for forgiveness.3
The SBA will remit the forgiveness payment, plus any interest accrued through the payment date, within 90 days of the lender’s payment request. If a lender denies a forgiveness request, it must notify the borrower in writing. Borrowers have 30 days from that notice to request the SBA to review the lender’s denial.
If the SBA selects a loan for review, it will notify the lender. Within five days of such notice, the lender must notify the borrower of the SBA’s review and provide the following documentation to the SBA:
- The borrower’s PPP loan application form.
- The borrowers PPP loan forgiveness application and all supporting documentation.
- The borrower’s Schedule A Worksheet to the PPP loan forgiveness application.
- A signed and certified transcript of the borrower’s account.
- An executed copy of the PPP promissory note.
Lenders may not approve forgiveness applications with respect to PPP loans under SBA review.
Lender Fees and SBA Guarantee
IFR #15 also provided that a lender will not be eligible for processing fees if the SBA determines a borrower was ineligible for a PPP loan, and the SBA has one year from the loan disbursement date to clawback processing fees paid on ineligible loans. A determination of ineligibility will not affect the SBA’s guaranty of a loan if the lender otherwise complied with the underwriting and documentation requirements of the CARES Act and the SBA’s guidance issued pursuant thereto.
Taft attorneys are available to help both borrowers and lenders navigate the entire PPP loan process. For further information, please contact any member of Taft’s SBA Task Force.
Please visit our COVID-19 Toolkit for all of Taft’s updates on the coronavirus.
1 The SBA is preparing a separate Interim Final Rule that will outline the process for borrowers to appeal adverse determinations made by the SBA in its review.
2 Borrowers cannot resubmit if the SBA has reviewed the forgiveness application and denied forgiveness.
3 Lenders may, but are not required to, provide the SBA with the PPP Borrower Demographic Information Form.