Paycheck Protection Program Loan Forgiveness
The Requirements: What You Need to Know
May 23, 2020
NOTE: This is a longer than usually newsletter but the information in this newsletter is of extreme importance to those that have a PPP loan. Please read it all to understand your role in getting your PPP loan forgiven. You need to understand these rules and be prepared to file the application immediately following the end of the eight-week period before the rules change for the worse.
For those who received a loan from the SBA’s Paycheck Protection Program (PPP) understood that getting this loan came with the potential of having the loan converted to a grant and being partially or fully forgiven. The SBA has released the Loan Forgiveness Application. Those applications will start being filed by the first recipients of the loans in approximately two weeks. The earliest that you may file for forgiveness is 8 weeks after receiving the loan.
As a quick review the loan amount was calculated based upon your average monthly payroll, multiplied by 2.5. It is important to remember that the program’s goal was for businesses to maintain its payroll and headcount. The intention of the loan was not for general working capital. There are certain other “essential” expenses covered by the loan – the “0.5” part of the loan calculated amount. In summary 75% of the loan was to be used for payroll and 25% for rent, lease, business mortgage interest and utility expenses.
As we all know the “devil is in the details.” Let’s take a look to see how much of the loan you may qualify to get forgiven. For the amount of the loan not forgiven, you pay it back over 18 months (it is a two-year loan with the first six months not requiring payment, all at 1% interest). The forgiveness application is filed with your lender not the SBA and the lender has 60 days to notify you of the amount forgiven. Be aware the IRS has ruled that business expenses covered by the forgiven amount of the loan, cannot be deducted as a business expense. More on this later.
The Application: The SBA released the 11 page PPP Loan Forgiveness Application. The application covers three different forgiveness calculations: Payroll, Headcount and Other Expenses in determining how much of the loan qualifies for forgiveness.
1. Disclosure of the payroll and qualifying non-payroll costs that the business has spent over the eight-week period since it received its PPP funds
2. Calculation of the reduction in the forgiveness amount if you have reduced pay for employees greater than 25 percent or if you have not brought back the same number of full-time equivalent employees (FTE). The FTE rule requires a business to reduce its forgiveness request if it does not bring back the same number of employees that it had pre-pandemic. The application does provide for a waiver of this reduction if the business failed to bring back its same employee count during its eight-week period but later brought back the same number of employees by June 30, 2020. In my opinion this may be area of concern in the calculation. If you disclosed number of employees on the application not the number of FTE’s you may have a reconciled item that may work against you.
3. The 75 percent payroll cost test, which states that the forgiveness request must be comprised of 75 percent payroll costs. The other 25 percent can only be rent, lease, mortgage interest debt and utilities.
Covered Period and Alternative Covered Period (covered period): The application allows a borrower to select as the covered period either the 8-week (56-day) period from the first disbursement date of the PPP loan or, if more convenient to align with a borrower’s payroll schedule, an alternative 8-week period that begins on the first day of the borrower’s first pay period following the loan disbursement. Whichever period the borrower selects must be used consistently through the application. Note that while the borrower may choose to use the alternative covered period for payroll, it may not do so for nonpayroll costs.
Definition of Other Expenses: When the CARES Act was passed it was unclear whether the lease of personal property was an amount that could be included in rent, and thus forgiven. The forgiveness application specifically states that rent includes the following: “Business rent or lease payments pursuant to lease agreements for real or personal property in force before February 15, 2020 (business rent or lease payments).”
While office and storefront and other real property was going to be included, the application now makes it clear that personal property items such as copiers, servers, autos and other common items of personal property that are leased by a business can be includable in the non-payroll costs that may be forgiven. Similarly, a business “mortgage interest payment” includes loans for real property and personal property, and as a result interest paid on loans for equipment, autos and other personal property items are includable and can be forgiven.
The application also defines utility expenses as “...electricity, gas, water, transportation, telephone or internet access, for which service began before February 15, 2020.” Most of these utility expenses are straightforward. What falls under transportation is uncertain, but SBA guidance appears to define transportation costs as gas and other auto expenses that would usually be part of the auto deductions on the business-tax return. Services purchased through the internet i.e. cloud storage or other subscriptions are not part of utility expense.
All eligible non payroll costs must be paid during the covered 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 covered period. Eligible nonpayroll costs cannot exceed 25% of the total forgiveness amount.
Average FTE Calculation: In determining FTE before the pandemic and during the eight-week period, the SBA has given two alternative methods of calculation.
1. The first option is to take the average number of hours paid each week for each employee, divide by 40 and round the total to the nearest 10th. The maximum number of hours per employee is 40 or 1 FTE. Since the calculation method tracks each employee by the hours they worked, and since it is the same method used pre-pandemic and during the eight-week period, it will fairly reflect the businesses payroll costs and the hours worked without having to worry about whether an employee makes the cut as a full-time equivalent or if they are part-time.
2. The SBA is also allowing for a simpler method that assigns 1.0 for employees who work 40 hours or more per week and 0.5 for employees who work fewer than 40 hours. While this may work for some small businesses, there can be some losers in this method, as you may have someone who worked 35 hours who is now only being counted at 0.5 under the simple method but would be 0.9 under the traditional method.
There are exceptions to your FTE calculations. Employees who were laid off or furloughed may not wish to be rehired. If the employee rejects your re-employment offer, you may be allowed to exclude this employee when calculating forgiveness. To qualify for this exemption:
o You must have made a written offer to rehire in good faith
o You must have offered to rehire for the same salary/wage and number of hours as before they were laid off
o You must have documentation of the employee’s rejection of the offer
If any of the following conditions apply to an employee, you may also qualify for an exemption:
o Fired for cause
o Voluntarily resigned
o Voluntarily requested and received a reduction of their hours
Employees who reject offers for re-employment may no longer be eligible for continued unemployment benefits.
Reminder: If you spend 75% of your loan on payroll but do not have the same pre pandemic FTE your forgiveness will be reduced based upon the percentage reduction of your FTE. For example, if your loan was $50,000 (75% for payroll - $37,500; 25% for other costs - $12,500) and you use the full $50,000 as stated during the covered period and your pre pandemic FTE was 10 but your covered period FTE is 7, your forgiveness will be $35,000 (70%)
Documentation of Payroll Costs: For payroll costs, the business must outline these on Schedule A Worksheet and must identify each employee paid during the eight-week period. The business must also identify employees paid at an annualized rate below $100,000 in 2019 on one schedule and employees paid at an annualized rate over $100,000 on another schedule. The business owner’s compensation is included on a separate line on the forgiveness application, but still calculates into the application like any employee. No employee or owner can have cash/wage compensation that is forgiven greater than the annualized eight-week amount of $15,385. This cap does not include health insurance and retirement contributions paid by the business for employees. Self-employed individuals do not get the benefit of health insurance or retirement contribution (see Owner Compensation Replacement section for explanation).
To document the payroll costs, the SBA is requiring each of the following:
1. Bank accounts or third-party payroll service reports documenting the cash compensation paid to employees.
2. Tax forms (or equivalent third-party payroll service provider reports) for the periods that overlap with the covered period. For tax forms, the SBA is requesting payroll tax forms (usually 941) and state quarterly wage and unemployment filings.
3. Payment receipts, cancelled checks or account statements documenting the amount of employer contributions to employee health insurance and retirement plans.
Owner Compensation Replacement: So far as discussed is how to get the payroll part of the PPP forgiven if you have employees. But what about those who don’t have employees – the self employed or sole proprietor. A concept called owner compensation replacement was introduced to help answer that exact question. When you qualified for your loan you took your net profit from 2019 and divided it by 12 and received 2.5 times that amount as the maximum amount of the loan you qualified for PPP. This is basically 10 weeks of your net profit. Since as a sole proprietor, you likely do not have payroll to spend those funds on, owner compensation replacement will help you receive forgiveness. If you are subject to owner compensation replacement you can automatically receive eight weeks’ worth of net profit forgiven – this is the owner compensation replacement concept. In order for the funds to be fully forgiven, the remainder of your PPP funds will need to be spent on the approved expenses previously discussed. The SBA rules emphasize there is no forgiveness provided for retirement or health insurance contributions made for self-employed individuals (independent contractors or sole proprietors) or General Partners, under the reasoning that “such expenses are paid out of their net self-employment income.” Net self-employment income is determined after reduction for contributions made towards employee retirement and health insurance expenses on the Form Schedule C and Form 1065. Such filers are not allowed to take deductions for contributions to their own retirement plan or health expenses, which is apparently the reasoning that the SBA is following for not allowing self-employed individuals or partners in a partnership to take health insurance and retirement plan costs into account.
To calculate the amount of owner compensation replacement eligible for your claim for forgiveness, take the 2019 net profit from your Schedule C and multiply that by 8/52 or 0.154. You will have to submit your Schedule C to your lender for documentation.
The updated guidance provided by the SBA does not allow for self-employed individuals to claim the entire amount of the PPP fund as income replacement. You still need to show the expenses for rent, lease, mortgage interest and utilities.
Still Unknown: It is unclear if owner’s compensation replacement will be applicable to all entities that don’t have a payroll. As this is currently the only information that has been released for self-employed people it may be assumed that this will carry over to other type of non-payroll entities that received the PPP. Hopefully there will be more guidance on this forthcoming.
Documentation of Rent, Lease, Mortgage Interest and Utilities: To document the approved non-payroll costs of rent, lease, mortgage interest and utilities, the SBA is requiring existence of the obligation/service prior to February 15, 2020 and evidence of payments during the eight-week period.
To document rent or lease payments, a copy of the lease agreement must be produced showing it was in force before February 15, 2020. To document the payments, the small-business owner will need to produce copies of account statements from its landlord/lessor showing the payments or cancelled checks evidencing the payments made during the eight-week period.
The documentation required for utility payments includes an invoice or statements from February 2020 showing the utility service in place. To document payments made during the eight-week period, the business can use account statements showing the payments made, cancelled checks or bank-account statements showing the payment.
Accuracy: Attention to detail and a correctly completed forgiveness application will be key to ensuring the maximum amount forgivable. Understanding what is in the application now will greatly increase a small business's chances of receiving maximum PPP loan forgiveness. While there are still unanswered questions, reviewing the PPP forgiveness loan application is a big step forward.
SBA Review: Borrowers that, together with their affiliates, received PPP Loans in excess of $2 million are required to check a box on the application indicating as such. Presumably, this will be used to flag applications required to be reviewed by the SBA. The SBA has stated that loans under $2 million will not be subject to audit. In addition, the SBA is requiring that any borrower who has any form of loan forgiveness must keep its loan records and documentation for six years from when the loan is paid in full.
Certifications and Materials: Borrower must certify (among other certifications) that the forgiveness amount was used only for eligible expenses, has been appropriately reduced (for compensation or average FTE reductions), does not include non-payroll costs in excess of 25%, and does not exceed 8-weeks’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner (capped at $15,385 per individual). The application also reinforces that there are potential criminal charges for false claims in connection with the information provided in the application or supporting documents or if funds were knowingly used for unauthorized purposes
Taxes: Amounts forgiven are not taxable income to the borrower. However, the IRS has held that a borrower whose PPP loan is forgiven may not deduct the expenses that relate to the forgiven amount. This is a backdoor attempt of taxing the loan proceeds. There are some bipartisan efforts to reverse that decision but it is not yet clear if they will be successful. Commentary has stated that this is in direct contradiction to what the CARES Act intended. I would expect that sometime before the end of the year there will be a technical corrections bill from Congress clarifying these types of matters.
Extension of the Covered Period: When the Senate adjourned for the Memorial Day recess a proposal to increase the covered period to 16 weeks from eight weeks was pending. It would also allow businesses to use the loans to purchase personal protective equipment for employees and to pay for other "adaptive investments" needed to reopen safely.
The proposal is different than one that the House plans to pass. The House legislation would extend the covered period to 24 weeks, eliminate the requirement that 75 percent of the money be spent on payroll — a provision left out of the Senate compromise.
The Senate bill also includes new legal protections for banks that relied on borrower certifications and documentation when making the loans. Stay tuned for more information on this.
Please understand that this newsletter was created and put together from documents that I researched. The one thing that has been constant with this program has been change. I will not be surprised if changes come out especially after the initial forgiveness applications are filed and reviewed. Remember the final say as to your forgiveness sits with your lender. The lender is incentivized by the SBA to make sure this is done correctly – loan granted according to the rules and forgiven according to the rules. I would expect that you may get some guidance from your lender when it is your time to file for forgiveness. As always, I am making myself available to those that need help – clients and non-clients alike.
Lastly, in trying to keep in compliance with social distancing guidelines, I am now offering to pick up your tax documents and discuss your tax situation either over the phone or via Zoom or Skype. You can also scan your documents into a PDF and email (HunterTaxConsulting@gmail.com) to me. Also, they can be mailed to my P O Box.
As more information becomes known I will keep everyone informed. Feel free to reach out to me to discuss your situation. Be safe everyone.
Harry E. Hunter
Hunter Consulting, Inc.
May 24, 2020