While we all wait for the U.S. Small Business Administration (SBA) to release its Interim Final Rule providing specific guidance and instructions regarding PPP loan forgiveness, which was originally due to be released April 26, 2020, here is what we know so far. PPP loan forgiveness is based on the borrower’s eligible payroll costs and eligible non-payroll costs “incurred and paid” during the 8-week period measured from when the PPP loan funds were first disbursed. This 8-week period is referred to as the “Covered Period.” Loan forgiveness will be determined by looking at the loan amount received by the borrower and the eligible costs incurred and payments made by the borrower within the Covered Period.
Costs Eligible for Loan Forgiveness
Payroll Costs. The primary intent of the Paycheck Protection Program is to enable employers to keep their employees on the payroll during the period of COVID-19 business interruption. The CARES Act defines “payroll costs” and specifies the costs that are eligible for loan forgiveness:
Payroll costs eligible for loan forgiveness:
- Salary, wages, commission or similar compensation paid to employees (this includes all cash compensation for work, including stipends and allowances)
- Payments for vacation, parental, family, medical or sick leave
- Dismissal or separation payments
- Payments for the provision of group health care benefits, including insurance premiums
- Payments for retirement benefits
- State or local payroll taxes
Payroll costs not eligible for loan forgiveness:
- Payments to an independent contractor
- Cash compensation in excess of $100,000
- The employer’s share of federal payroll taxes
- Qualified sick leave and qualified parental leave wages for which a payroll tax credit is allowed under the Families First Coronavirus Response Act (FFCRA)
Non-Payroll Costs. The CARES Act allows a borrower to spend a portion of PPP loan proceeds on certain non-payroll costs while still maintaining eligibility for loan forgiveness:
Non-payroll costs eligible for loan forgiveness:
- Interest payments on a mortgage loan incurred in the ordinary course of business on real or personal property that was in existence on February 15, 2020
- Rent payments under lease agreements in existence on February 15, 2020
- Utility payments for electricity, gas, water, transportation, telephone or internet for which service was in existence on February 15, 2020
Limitations of and Reductions to PPP Loan Forgiveness
There are certain limitations and possible reductions in the amount of PPP loan proceeds that may be forgiven based on (1) how much of the PPP loan proceeds were used to pay for what type of expense, (2) whether any portion of the loan amount is already subject to forgiveness under another provision of law, (3) whether the employer has reduced its full-time employee headcount, and (4) whether the employer has reduced salary or wage rates for employees.
PPP loan forgiveness is limited as follows:
Percentage Limitation of Non-Payroll Expenses and Deduction of EIDL Advance
- Not more than 25% of the loan forgiveness amount can be attributable to non-payroll costs (i.e. mortgage interest, rent and utilities). If a borrower uses more than 25% of PPP loan proceeds for non-payroll costs, those excess amounts must be paid back under the terms of the loan.
- Proceeds from any advance up to $10,000 on an Economic Injury Disaster Loan (EIDL) will be deducted from the loan forgiveness amount. The CARES Act will not allow a “double dip” on the forgivable $10,000 EIDL advance.
Reduction Based on The Number of Employees and Reduction Based on Decrease in Salary and Wages
As indicated earlier, the primary intent of the Paycheck Protection Program is to enable employers to keep their employees on the payroll during the period of COVID-19 business interruption. As such, the law imposes limitations on PPP loan forgiveness if the employer reduces its employee headcount or reduces amount of salary and wages paid to its employees. PPP loan forgiveness will be reduced (a) in proportion to the decrease in the average monthly number of full-time-equivalent employees (“FTE”) during the Covered Period as compared to a reference period and (b) dollar for dollar by the amount of any reduction in total salary or wages of an employee (other than those who have annualized pay in excess of $100,000, who are already capped out) that is in excess of 25% of the total salary or wages of any employee during the Covered Period as compared to a reference period.
Reduction Based on Number of Employees. The PPP calls for a comparison of the average number of FTEs that the employer has each month during the Covered Period to the average monthly number of FTEs the employer had during one of two base periods. The employer may choose either (i) the period from February 15, 2019 to June 30, 2019, or (ii) the period from January 1, 2020 to February 29, 2020, to establish its FTE base. (It would benefit the employer to run both calculations and choose the base period with the lower number of FTEs, thereby making the FTE retention component easier to satisfy). The PPP speaks of FTEs, not specific employees. Therefore, it does not matter if a different person was sitting in the seat during the base period and Covered Period. The headcount is what is important.
The loan forgiveness amount is subject to reduction by multiplying it by the following fraction:
The numerator would be the average number of FTE employees per month employed by the borrower during the Covered Period, and the denominator is, at the election of the employer, either:
- The average number of FTE employees per month employed during the period beginning February 15, 2019 and ending June 30, 2019, or
- The average number of FTE employees per month employed during the period beginning January 1, 2020 and ending February 29, 2020.
For seasonal employers, as determined by the SBA, the denominator is the period beginning February 15, 2019 and ending June 30, 2019.
Put another way:
Loan amount times the average number of FTEs per month for the 8-weeks beginning on loan origination divided by: Option 1: average number of FTEs per month from February 15, 2019 to June 30, 2019, or Option 2: average number of FTEs per month from January 1, 2020 to February 29, 2020. For seasonal employers: the average number of FTEs per month from February 15, 2019 to June 30, 2019.
There is an opportunity for an employer to “eliminate a reduction” by hiring back employees by a certain date. If an employer has “reductions” because of layoffs or furloughs between February 15, 2020 and April 26, 2020 (30 days after enactment of CARES Act) and the employer “eliminates the reduction in the number of” FTEs by June 30, 2020, the amount of loan forgiveness will be determined without regard to the reduction in FTEs that occurred between February 15, 2020 and April 26, 2020. By way of example, if an employer furloughed some employees between February 15, 2020 and April 26, 2020 but rehired them (or new employees) by June 30, 2020, those employees would be counted as part of the total FTEs during the entire Covered Period. This is a limited exception that applies to a limited time period, but it may be helpful to employers who were forced to lay off or furlough employees in the early days of the COVID-19 shutdown.
On May 3, 2020, the SBA issued additional guidance on the question of rehiring furloughed workers. The SBA posed and answered the following question: Question: “Will a borrower’s PPP loan forgiveness amount . . . be reduced if the borrower laid off an employee, offered to rehire the same employee, but the employee declined the offer?” Answer: “No. . . The interim final rule will specify that, to qualify for this exception, the borrower must have made a good faith, written offer of rehire, and the employee’s rejection of that offer must be documented by the borrower. Employees and employers should be aware that employees who reject offers of re-employment may forfeit eligibility for continued unemployment compensation.”
Reductions Based on Salary and Wages. PPP loan forgiveness is reduced by the amount of any reduction in total salary or wages of any employee (except employees who made more than $100,000 in 2019) during the Covered Period that is in excess of 25% of the total salary or wages of the employee during the most recent quarter that the employee was employed before the Covered Period. Note that, unlike the total number of employees, which is based on FTEs, the salary and wage reduction calculation is based on individual employees for whom the employer reduced pay. Like the FTE reductions noted above, salary reductions can also be eliminated by June 30, 2020, which then eliminates this reduction.
For salary and wage reductions, the loan forgiveness amount is subject to reduction by an amount determined under the following formula:
- Identify the employees who did not receive during any single pay period in 2019 wages or salary at an annualized rate of more than $100,000. Just focus on the employees who made less than $100,000 in 2019.
- Then, compare each of these employee’s wages or salary during the 8-week Covered Period to his or her salary or wages during the first quarter of 2020.
- For any employee whose salary or wages during the Covered Period decreased by more than 25%:
- Multiply the first quarter wages or salary by .75
- Subtract the product from the salary or wages paid in the Covered Period.
- Add up all amounts computed for all covered employees resulting from step three.
The total dollar amount calculated for all covered employees who suffered a greater than 25% reduction in pay will reduce the PPP loan forgiveness amount dollar for dollar.
Put another way:
The employee must have been paid at least 75 percent of what that individual employee’s wage or salary was in the most recent full quarter prior to the PPP loan origination date. If not, any amount that is below the threshold will not be forgiven.
What Terms Would Apply to any PPP Loan Amount That is not Forgiven?
The principal amount of the PPP loan and any accrued interest that is not forgiven will continue as a loan on its original terms, including:
- A maturity date that is two years from the date of disbursement
- Payments deferred during the first six months
- Interest rate of one percent (1%) per annum
- No prepayment penalty
To receive loan forgiveness, the CARES Act requires that the employer submit a forgiveness application to its lender. At least the following documentation will need to be included to substantiate the request:
- Documentation verifying the number of FTE employees on the employer’s payroll and their pay rates for the Covered Period and the prior periods used by the employer in the formulas to calculate any reduction in loan forgiveness.
- Payroll tax filings reported to the IRS and state income, payroll, and unemployment tax filings.
- Documentation, including cancelled checks, electronic payment and transfer receipts, account statements or other documents verifying payments on mortgage interest obligations, rent payments, and utility payments.
- A certification from an authorized representative of the business that the information submitted is true and complete, that the amount for which forgiveness is sought was used for eligible purposes (i.e. to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, and make utility payments).
Employers should keep detailed records about how the PPP loan proceeds were used during the Covered Period. Good recordkeeping and substantiation will be critical for loan forgiveness.
The initial guidance indicates that a lender does not need to conduct any verification if the employer submits documentation supporting its request for loan forgiveness and attests that it has accurately verified payments for eligible costs. Of course, all of this can change when the SBA issues its rules on PPP loan forgiveness. The SBA and Treasury have indicated that borrowers who received more than $2 million and who request forgiveness will be subject to audit.