*The original article posted on April 17, 2020 has been updated to reflect changes as of April 27, 2020.
On April 16, 2020, the Small Business Administration (SBA) exhausted its $349 billion appropriations of funds under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) - Paycheck Protection Program (PPP), as well as additional funds allocated for the SBA COVID–19 Disaster loan program. The SBA posted, “The SBA is currently unable to accept new applications for the Paycheck Protection Program based on available appropriations funding.” Congress negotiated a new supplemental bill to refill both SBA loan program’s coffers, signed into law on April 24, 2020.
Many small business owners have or will receive funding under the PPP and it is vitally important for these businesses to focus on the eligible uses of loan proceeds and maximize the amount of forgiveness each business can receive. Loan forgiveness will be fact sensitive and dependent upon actions taken by borrowers during the eight-week period that begins on the date the borrower receives its loan proceeds, decisions surrounding the use of proceeds, reduction in employee count and any salary reductions of 25% or more for employees earning less than $100,000 annually. Guidance on the loan forgiveness portion of the PPP has been unclear in certain instances and the SBA had until April 26, 2020, to release additional guidance related to Section 1106 of the CARES Act (PPP loan forgiveness). As of today we are still waiting for that guidance. Below is a summary of the loan forgiveness provisions within the CARES Act and subsequent guidance issued through Interim Final Rules and authorized FAQs from the Department of Treasury, as of April 27, 2020.
General Loan Forgiveness
Generally, the PPP allows loan forgiveness for four categories of expenses incurred and payments made during the “covered period” (i.e., the eight-week period commencing on the date the borrower receives its loan proceeds). The categories are:
- Payroll costs, including gross salaries, commissions, wages and similar cash compensation up to a $100,000.00 cap, annualized per employee (maximum of $15,385 per employee over the eight-week period), employer-paid health care benefits, including insurance premiums, vacation, parental, family, medical or sick leave payments, payments of cash tips or equivalent, retirement contributions, and employer paid state and local taxes on payroll.
Payroll costs for independent contractors, self-employed individuals and sole proprietors are defined as any compensation, income net earnings from self- employment or similar compensation no more than $100,000.00 per year, as prorated over the eight-week period.
Payroll costs cannot include: The employer’s portion of federal payroll taxes, compensation in excess of $100,000, compensation to any employee whose principal place of residence if outside of the United States, or any payments made under Sections 7001 or 7003 of the Families First Coronavirus Response Act.
- Rent and lease payments.
- Utilities, including electricity, gas, water, gas for business vehicle, transportation, telephone and internet.
- Interest Payments Only on a Mortgage or Vehicle Loan (strictly used for business), including any business mortgage obligation on real or personal property, which can include interest on an auto loan for a vehicle used for business purposes. Payments of principal are not permitted.
Items two through four listed above must have been obligations in existence on Feb. 15, 2020, to be eligible. Furthermore, 75% of the loan proceeds must be used on payroll costs whether or not loan forgiveness is sought; but if loan forgiveness is sought, 75% of the loan proceeds must be used for payroll costs within the eight-week period. No more than 25% of the loan proceeds may be used for items two through four above. The total loan amount eligible for forgiveness will be up to the full principal loan amount and any interest accrued during the six-month payment deferral period following disbursement of loan proceeds.
It is possible for a borrower to have the loan forgiven in full, so long as the borrower:
- Uses 75% of the loan proceeds for payroll costs.
- Uses all loan proceeds for the forgivable purposes noted above.
- Maintains its average employee count during the eight-week period consistent with its comparable period, for most businesses that is either Feb. 15, 2019, through June 30, 2019, or January 1, 2020, through Feb. 29, 2020 (borrower’s choice).
- Does not reduce the compensation of an employee making $100,000 or less by more than 25%, as compared to the employee’s average compensation during the last full quarter.
However, if an employer does not meet the requirements identified in three and four above, it may qualify for an exception if, prior to June 30, 2020, the employer rehires or reinstates the compensation of an employee that was impacted between Feb. 15, 2020, through April 26, 2020. If an employer still does not meet the requirements identified in three and four above, after giving effect to the exception in the preceding sentence, then the amount of the loan eligible will be reduced ratably. Any portion of the loan that is not forgiven by Dec. 31, 2020 will remain outstanding and amortize over an 18 month period. The first six months of loan payments are deferred. The amount of the loan forgiven will NOT need to be reflected as cancellation of indebtedness (COD) income for federal income tax purposes.
A borrower receives a loan amount of $100,000 and spends 75% of the loan proceeds on payroll costs and uses all of the remaining funds on qualifying expenses. The borrower’s average number of full-time equivalent employees during the eight-week period is 90, and the borrower’s average number of full-time equivalent employees from January 1, 2020, through Feb. 29, 2020, is 100. Hence the maximum loan forgiveness amount would be $90,000 (90/100 = 90%; $100,000 x 90% = $90,000). The remaining $10,000 would become a two-year term loan at a 1% interest rate.
Salary Reduction Example
A borrower receives a loan amount of $500,000.00 and spends 75% of the loan proceeds on payroll costs and uses all of the remaining funds on qualifying expenses. An employee’s salary in the first quarter of 2020 is $100,000, and the same employee’s salary during the eight-week period is $49,999 (which would yield a reduction in gross pay, in excess of 25%, of approximately $3,846.31 (8/52 x $25,001.00) during the eight-week period). The amount of loan forgiveness reduction would be reduced dollar for dollar by the amount of salary reduction in excess of 25% during the eight-week period, in this instance $3,846.31, hence only $496,153.69 ($500,000.00 – $3,846.31) would be eligible for loan forgiveness and the remaining $3,846.31 would become a two-year term loan at a 1% interest rate.
A borrower receives a loan amount of $1,000,000 and spends 75% of the loan proceeds on payroll costs and uses all of the remaining funds on qualifying expenses. The borrower’s average number of full-time equivalent employees from Feb. 15, 2019, to June 30, 2019, is 100. On Feb. 15, 2020, the borrower’s average number of full-time equivalent employees is still 100; however, sometime after Feb. 15, 2020, the borrower terminates 10 employees and the borrower’s average number of full-time equivalent employees during the eight-week period following disbursement of loan proceeds drops to 90. By June 30, 2020, the borrower has rehired its 10 employees or hired 10 new replacement full-time equivalent employees. The maximum amount of loan forgiveness would be the full $1,000,000 and no reduction will be required due to the momentary decrease in number of full-time equivalent employees.
Some uncertainty exists when interpreting the CARES Act and relevant guidance related to loan forgiveness. For example, the CARES Act permits borrowers to restore any reductions in workforce or wages by June 30, 2020, but it is unclear how exactly to execute such restorations. Additionally, guidance has not been issued to determine if borrowers will be punished if employees refuse to come back to work because they make more on unemployment, or if employees voluntarily quit. If a borrower spends 70% of its loan proceeds on payroll costs, but 30% on qualifying expenses, will the SBA truly not allow any loan forgiveness?
Borrowers need to plan their use of the loan proceeds now so loan forgiveness can be maximized and to put practices in place for documenting the use of loan proceeds that prove how the funds were spent and that they were spent on payroll costs and qualified expenses. Each borrower will be required to present detailed payroll and financial records as evidence to its lender when requesting loan forgiveness at the end of the eight-week period to prove loan proceeds were properly used and to determine what portion of the loan amount can be forgiven. See SBA Part Eight for information on when PPP loans are misused. Borrowers can begin providing this documentation and requesting forgiveness in week seven of its eight-week period, though the format of the required application has not been determined as of today.
For borrowers that require additional financial assistance beyond the PPP, the Federal Reserve Bank is in the process of developing its Main Street Lending Program, which is expected to be open to all PPP participants.
Additional guidance has added heightened scrutiny and confusion as to the certification required of all PPP loan applicants stating “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient…" This certification must be made “in good faith, taking into account applicant’s current business activity and ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.” Any borrower that applied for a PPP loan prior to April 24, 2020 and “repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith.” The Administrator, in consultation with the Secretary, determined that this safe harbor is necessary and appropriate to ensure that borrowers promptly repay PPP loan funds that the borrower obtained based on a misunderstanding or misapplication of the required certification standard. See SBA Part Nine for information on the PPP loan certification.
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