The Small Business Administration (“SBA”) and Treasury have issued new interim final regulations on provisions of the Paycheck Protection Program Flexibility Act of 2020, and revised the Paycheck Protection Program (“PPP”) loan forgiveness application to take into account the new law, separating the application form from the instructions and providing an EZ form that can be used by certain borrowers for loan forgiveness.
The law provides significant loosening of the rules for PPP Loan forgiveness, extending the time period during which expenses for forgiveness can be incurred from 8 weeks to 24 weeks and enabling businesses to use up to 40 percent (increased from 25 percent) of forgiveness for non-payroll items in applying for forgiveness. There is a new safe harbor that can be used to avoid a reduction in allowable expenses used for forgiveness and the date at which annual salary/hourly wage and employment levels can reach pre-COVID levels is changed from June 30, 2020, to the earlier of the loan application date or December 31, 2020.
The interim final regulations clarify the definition of owner-employee to include any owner of a C corporation, an S corporation, a partnership or LLC and an individual operating a business as a sole proprietor. The regulations provide detailed limitations on the amount of payments to those individuals that can be used for loan forgiveness. The borrower needs to represent that the forgiveness amount does not include compensation of more than either:
- Two and a half months’ worth of 2019 compensation (including gross wages, group health plan costs and retirement contributions) for any owner-employee, self-employed person or partner, capped at $20,833 per person if a 24-week covered period is used, or
- Eight weeks’ worth of 2019 compensation, (including gross wages, group health plan costs and retirement contributions) for any owner-employee, self-employed person or partner, capped at $15,385, if an eight-week covered period is used.
Should My Covered Period be 8 or 24 Weeks?
The legislation allows borrowers which received PPP loans before June 5, 2020, to choose whether to use an 8 or 24 week period for the covered period. Under either period, the Alternative Payroll Covered Period rules and the rules allowing payment after the end of the period for costs incurred during the covered period continue to apply. The maximum compensation that can be included for employees, other than owner-employees, is $15,385 if the eight-week covered period is used and $46,154 if the 24-week covered period is used.
Forgiveness applications can be filed before the end of the covered period. However, in that case any reduction in annual salary or hourly wages that is required must be taken for the entire 8 or 24 weeks, even if the forgiveness application is filed before the end of the covered period. In addition, if a borrower cannot meet one of the rules exempting it from the required reduction based on full time equivalent (FTE) employment levels, the borrower will need to wait for the end of the covered period to properly compute that amount.
Using eight weeks as the covered period limits the time period during which employment levels and wages must be maintained, but provides a shorter time for incurring expenses to be used for forgiveness. To avoid the required adjustment for annual salary/hourly wage or FTE employment level reductions, a borrower can restore levels to the February 15, 2020, levels by the earlier of the date the application is filed or December 31, 2020.
The forgiveness application provides that the FTE reduction applies to the total allowable expenses included in the loan forgiveness application. Thus, many borrowers will be better served by using a 24-week covered period, if they cannot meet one of the safe harbors to avoid a reduction in the forgiveness amount. For example, assume a borrower has a $1,000,000 loan and, at the end of the eight-week period, has $1,000,000 of allowable expenses and a required FTE reduction of 10 percent, requiring the expenses to be reduced by 10 percent. Under these facts, only $900,000 of expenses could be used for forgiveness and $100,000 of the loan would need to be repaid with interest. Assume further that this borrower continues layoffs and, at the end of the 24-week period, has incurred $2,000,000 of expenses to use for forgiveness and a required FTE reduction of 40 percent. In this example, the $2,000,000 of expenses are reduced by 40% to $1,200,000 resulting in forgiveness of the entire $1,000,000 loan by using the longer period.
Avoiding the Expense Reduction Rules
Maximum loan forgiveness is based on maintaining annual salaries or hourly wages and FTE employment levels. These are two separate reductions, each of which must be made unless a safe harbor can be used to avoid the required reduction.
There are three ways that a borrower can avoid having the loan forgiveness amount reduced as a result of a reduction in FTE employment levels or, for individuals paid less than $100,000 annualized for any pay period in 2019, a reduction in annual salary or hourly wage of more than 25 percent compared to the wages paid in the first quarter of 2020.
- There was no reduction in the number of employees or the average paid hours of employees between January 1, 2020 and the end of the covered period (8 or 24 weeks) and, for individuals paidmore than $100,000 annualized for any pay period in 2019, there is no reduction in annual salary or hourly wage of more than 25 percent compared to the wages paid in the first quarter of 2020.
- In good faith, the borrower is 1) able to document being unable to operate, between February 15, 2020 and the end of the covered period (8 or 24 weeks), at the same level of business activity as the business was operating before February 15, 2020, due to compliance with requirements established or guidance issued by HHS, CDC or OSHA between March 1, 2020, and December 31, 2020, related to the maintenance of standards for sanitation, social distancing or worker or customer safety requirements related to COVID-19 and 2) for individuals paid more than $100,000 annualized for any pay period in 2019, there is no reduction in annual salary or hourly wage of more than 25% compared to the wages paid in the first quarter of 2020.
- The borrower reduced its annual salary/hourly wage or annual FTE employment levels during the February 15, 2020 to April 26, 2020 period and restored those levels to the February 15, 2020 pay period levels no later than the earlier of December 31, 2020 or the date the application is submitted. This safe harbor is applied separately for salary/hourly wage levels and FTE employment levels, such that meeting the safe harbor for one of those criteria will eliminate the reduction for that criteria, but not the other.
A borrower should first determine if these safe harbors can be met. If they can, then some or all of the annual salary/hourly wage and FTE employment level calculations can be avoided. If FTEs need to be calculated, the borrower cannot file for forgiveness before the end of the covered period, because the average weekly FTE employment levels must be determined through the end of the covered period.
Restrictions for Owner-Employees
The interim final regulations make clear that reductions on forgiveness amounts for owner-employees include limits for all business owners, regardless of entity type or ownership percentage. Loan forgiveness costs are limited to no more than $15,385 per owner-employee if the eight-week covered period is used and $20,833 if the 24-week covered period is used, each capped at the amounts paid to these individuals for compensation, group health benefits and retirement contributions during 2019 for either 8 or 24 weeks.
- For C corporation owner-employees, the amount is capped at 8/52 or 24/52 of their Box 1 Form W-2 compensation and group health benefits and retirement plan contributions both made on their behalf for the allocable period.
- For S corporation owner-employees, the amount is capped at 8/52 or 24/52 of their Box 1 Form W-2 compensation and retirement plan contributions made on their behalf for the allocable period.
- For partners and LLC members filing a Form 1065, partners and members are limited to 8/52 or 24/52 of .9235 times the SE income reported on line 14a of their 2019 Form 1065, Schedule K-1 (excluding the IRC Section 179 bonus depreciation deduction, unreimbursed business expenses and depletion for oil and gas properties).
- For Schedule C and F owner employees, the amount is capped at 8/52 or 24/52 of the 2019 net profit reported on Schedule C or F.
The interim final regulations and form instructions take into account the different tax treatment for group health benefits and retirement plan contributions for different categories of owner-employees and apply the dollar limits to all of these payments. This is not consistent with calculation of maximum amounts in the loan application.
Limits for Nonpayroll Costs
Payroll costs for loan forgiveness must total at least 60% of the forgiveness amount, down from 75% under prior law. Prepayments and past due amounts of rent and utilities paid during the covered period can be included in forgiveness costs, but no prepayment of interest for mortgages on real or personal property is permitted.
Income Tax Deduction for Forgiveness Amounts
There has been no change in the rule prohibiting costs used for loan forgiveness from being deducted for income tax purposes by the borrower. Borrowers funding 2019 retirement plan contributions during the covered period will want to carefully consider whether that amount should be used for loan forgiveness. Deducting retirement plan contributions in 2019 may provide the borrower with more tax savings than the savings for other costs paid during the covered period that would be deductible in 2020. The longer covered period gives borrowers the ability to determine what costs to include in the forgiveness application, minimizing the cost of the lost tax deduction in the case of retirement plan contributions that can be deducted in either year.
Loan Payment
Loan payments are not due until after the loan forgiveness application is submitted to the lender and the lender has notified the borrower of the forgiveness amount. A borrower must submit a loan forgiveness application within 10 months of the end of the covered period. If loan forgiveness is not requested by then, payments begin no earlier than 10 months after the end of the covered period with interest accruing for the entire period.
Documentation
Forgiveness will be verified by the bank and SBA. In doing so, the bank will require:
- The Application Form, including PPP Schedule A if not using the Form EZ.
- Bank account statements or third-party payroll service provider reports documenting the amount of cash paid to employees,
- Employment tax forms (e.g., Form 941) which overlap with the Covered Period or Alternative Payroll Covered Period and state quarterly business and individual employee wage reporting and unemployment insurance tax filings reported or to be reported, and,
- Payment receipts, cancelled checks or account statements documenting employer payments to group health and retirement plans.
- For borrowers using the EZ form, the average number of FTEs employed January 1, 2020, until the end of the Covered Period.
Non-payroll cost documentation will need to include documents to verify the existence of obligations or services on February 15, 2020, and the payments made during the Covered Period. Interest payments are documented with a lender amortization schedule and receipts or cancelled checks verifying payment during the Covered Period, or lender account statements from February, 2020, through one month after the end of the Covered Period verifying interest amounts and eligible payments. Rent and lease payments are documented with a copy of the current lease agreement and receipts or cancelled checks verifying payment during the Covered Period or lessor account statements from February 15, 2020, through one month after the end of the Covered Period verifying the payments. Utility payments are documented with copies of invoices from February 15, 2020, through the Covered Period and receipts, cancelled checks or account statements verifying eligible payments.
To document FTE employees, there will need to be documentation showing the average number of FTE employees on payroll per week between February 15, 2019 and June 30, 2019, January 1, 2020, and February 29, 2020, or, for seasonal employers, any consecutive 12-week period between May 1, 2019, and September 15, 2019, whichever the borrower is using for the forgiveness reduction calculation. This documentation may include payroll tax filings (e.g., Form 941) and state quarterly business and individual wage reporting and unemployment insurance tax filings that have been or will be reported and may cover periods overlapping the 8 or 24 week period.
All borrowers are required to maintain for 6 years, but not submit, all records relating to the PPP loan forgiveness, including documentation:
- Submitted with the PPP loan application,
- Supporting the borrower’s certifications as to the necessity of the loan and the borrower’s eligibility for the loan,
- Supporting the loan forgiveness application, and
- Demonstrating material compliance with PPP loan requirements.
