Yet MORE Clarification for Forgiveness of PPP Loans
Let us first start by hoping everyone is healthy and has been able to enjoy a long holiday weekend. We honor those that have served and are serving our country.
A week ago we sent out the newly published 3508 Loan Forgiveness Application for borrowers who were fortunate to receive funding through the Paycheck Protection Program (PPP). After letting everyone ponder over its nuances for several days, this weekend the SBA and Department of the Treasury both issued interim final rules related to the program.
The SBA final rule document deals mostly with their intended methods of reviewing loans and the obligations of the lenders and borrowers in this regard. While we have attached the 19 page document [page 7 to page 16 are key] here there are several specific points to know:
- The SBA reserves the right to review any PPP loan. There is no minimum amount for them to do so. Those rights extend to eligibility of the borrower, the calculation of loan, use of proceeds and the loan forgiveness amount.
- The borrower is required to retain its PPP documentation files for 6 years after that date the loan is forgiven or repaid in full.
- The lender is required to issue a decision to the SBA on a loan forgiveness application no later than 60 days after the receipt of a completed loan forgiveness application from a borrower.
The interim final rule from the Department of the Treasury deals more in detail with the forgiveness application and the requirements of form 3508. We have also attached that 26 page document here for those of you having trouble sleeping. [helpful hint – start reading at page 6 and stop reading after page 23]
Following is a synopsis of the document in which we will also try to answer some of the specific questions we are receiving from clients and others. We do believe that there will be more guidance and maybe even additional changes to come. PPP loans were first disbursed on April 3rd so many of you may be deep into the coverage period, therefore it is essential that you understand the requirements and act accordingly. Before going into the specifics, a couple of general points to understand:
- Many payroll companies are providing reporting to their customers. Do not assume they are right. We have seen several which are in fact incorrectly calculated. Do your due diligence before accepting them.
- Many people have asked, especially in the NY area, whether there will an extension of the coverage period from 8 weeks. Please note that as the 8-week period was included in the act itself, a change requires an Act of Congress. There are at the moment at least three bills that have been introduced that all include such an extension. Unfortunately, it is impossible to know what and when something will be enacted.
- Contact your bank now if you have not already done so. It is imperative that you understand their process and also their understanding as to what constitutes a forgivable expense.
The Specific Terms
The interim final rules reiterate that borrowers will be eligible for forgiveness in an amount equal to “the following costs incurred and payments made during the covered period” these “costs and payments” include (1) Payroll costs, (2) interest on mortgage obligations, (3) rent, and (4) utilities.
Payroll Costs – includes “salaries, wages, commissions, or similar compensation, cash tips or the equivalent, payment for vacation, parental, family, medical, or sick leave, allowances for separation or dismissal, payments for group health care coverage, including health insurance premiums and retirement, as well as payment of state and local taxes assessed on compensation of employees” (for example State unemployment insurance)
Interest, Rent and Utilities – the rules also give more specificity to the other three categories of forgivable payments.
A key disclosure with regard to the non-payroll costs that can be forgiven appears on page 12 of the interim final rule where it specifically states:
“A non-payroll costs is eligible for forgiveness if it was:
i. Paid during the covered period; or
ii. 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.”
The text goes on to to give an example regarding electricity bills, but presumably it would appear that interest that is accrued and owed as of the beginning of the 8-week coverage period before receipt of the PPP funds can be paid during the coverage period and be forgiven as well as interest accrued in the 8-week period as long as it is “paid on or before the next regular billing period” which follows the 8 week period.
Interest on debt can be forgiven on debt that had been incurred prior to February 15, 2020. The debt has to relate to any business mortgage obligation on real or personal property. There is a great deal of debate as to whether this also extends to debt that is secured by business property and not necessarily mortgaged such as asset-backed loans that are secured by accounts receivable. While we have our opinion on this, the best course of action is to talk to your lender and get their opinion. Frankly they are the parties who will be signing off on the forgiveness.
The rules appear to generally provide that rent is treated the same way and can be based upon rental of real estate or non-real estate assets as long as the lease was in force prior to February 15, 2020.
The rules also further define utilities as “business utility payments for the distribution of electricity, gas, water, transportation, telephone or internet services for which service began before February 15, 2020.” Most of these are self-explanatory; transportation services – not so much.
The 75% Rule
The final interim rules also state that total costs relating to interest, rent and utility payments “cannot exceed 25% of the loan forgiveness amount.” This provides an important distinction in that we can now be sure that total forgiveness is based upon expenses paid for payroll costs. If a borrower for example received total funds of $100,000 under the PPP but can only report $60,000 of payroll expenses during the coverage period but has another $30,000 of non-payroll costs that qualify; then other than the $60,000 of payroll costs that will be forgiven another $20,000 of non-payroll costs will be covered ($60,000 ÷ 75%). Therefore a total of $80,000 will be forgiven. The remaining $20,000 will become a two year loan at a 1% interest rate.
Payroll Timing and Related Considerations
Form 3508 introduced the concept of an alternative coverage period to better enable borrowers to match their actual payroll periods to the 8-week coverage period. Borrowers with a bi-weekly or more frequent payroll cycle may elect to match the covered period to the first day of their next payroll period after funding. Page 10 of the interim final rule provides an example. It is important that a borrower reviews its payroll cycle to maximize the effect for forgiveness.
The final interim rules also specifically include the payment of bonuses, hazard pay and payment to furloughed employees in payroll costs if paid within the covered period but only to the maximum of the $100,000 per annum ratable amount.
The final interim rules also address the issues of ownership and what can be forgiven. The rules state that owner-employees and self-employed individuals loan forgiveness amount can be no more than the lesser of 8/52 of 2019 compensation or $15,385 per person. Owner- employees are capped by the amount of their 2019 employee cash compensation and employer retirement and health care contributions. Schedule C filers are capped based upon 2019 net profit.
General partners are capped by the amount of their 2019 net earnings from self-employment with certain adjustments and no additional forgiveness is provided for retirement or health insurance contributions for self-employed individuals including Schedule C filers and general partners, as such expenses are deemed to be paid out of their self-employment income.
The limitation to 2019 income seems extremely harsh and the pundits believe there will be a technical correction on this specific issue. We will see.
Reductions to Loan Forgiveness Amounts
The total amounts that would otherwise be forgiven for payroll and the non-payroll costs described above will be reduced if there are reductions in the number of employees considered to be employed during the 8- week coverage period, and by certain reductions of compensation as to one or more particular employees. Buckle up, because this is where it gets tricky.
First of all everything is stated in terms of FTE’s (Full Time Equivalents). The regulations have determined that an FTE is someone who has worked 40 hours or more in a week. For employees who work less than 40 hours, borrowers may choose to calculate the full time equivalency in one of two ways. They can calculate the equivalent based on hours as a % of the 40 hours standard. So someone who works 30 hours would be considered an FTE employee of 0.75. Alternatively borrowers may elect to use a FTE of 0.5 for each part-time employee.
Then the borrower, after selecting either of these methods, must apply the method consistently for the covered period and the reference period that is used to compare and determine if any of the forgiveness amount is reduced.
What is the reference period? Good question – the borrower gets to select a period: i) February 15, 2019 through June 30, 2019; ii) January 1, 2020 through February 29, 2020; or iii) Seasonal employers have other choices. A borrower will obviously want to pick the period with the lowest number of FTE’s here.
If the average number of FTE employees during the covered period (or alternative covered period) is less during the reference period, then the total eligible expenses available for forgiveness is reduced proportionately. The text gives a very simple example. “If the borrower had 10 FTE employees during the reference period and this declined to 8 FTE employees during the covered period the percentage of FTE employees declined by 20% and thus only 80% of otherwise eligible expenses are available for forgiveness.”
Still with me? OK. Now let’s talk about the exceptions:
1. The reduction in the forgiveness amount will be waived if the borrower eliminates the reduction in FTE employees occurring in a different reference period (defined as between February 15, 2020 and April 26, 2020) by no later than June 30, 2020.
2. If a borrower offers to rehire employees or restore their hours and they refuse then that employee will be exempt from the loan forgiveness calculation assuming the borrower undertakes certain requirements.
3. Also, when an employee of a borrower is fired for cause, voluntarily resigns, or voluntarily requests a reduced schedule during the covered period the borrower may count such employee as the same FTE equivalency level as before the event occurred in calculating the forgiveness reduction amount. Essentially employers will “not be penalized for changes in employee headcount that are the result of employee actions and requests.” However, the borrower must keep records demonstrating the event.
The above deals with the reduction in head count and the regulations also include certain provisions relating to a reduction in the amount of loan forgiveness in reaction to a reduction in salaries instead of the actual reduction of FTE employees. One important clarification of the final interim rules is that a reduction in hours does not also qualify as a reduction in salary. So if an employee is cut from 40 hours a week to 20 hours a week this reduces them to a 0.5 FTE employee from a 1.0 FTE employee but it also does not mean that for the salary reduction test they have experienced a 50% decrease in salary.
With that important distinction out of the way what are the rules around the salary reduction provisions. Basically a reduction in an employee’s wages in excess of 25% will generally result in a reduction of the loan forgiveness amount unless an exception applies.
Generally, the borrower must, for each employee including those hired in 2020 who was not paid more than the annualized equivalent of $100,000, reduce the total forgiveness amount by the total dollar amount of the salary or wage reductions that are in excess of 25% of base salary between January 1, 2020 and March 31, 2020 (the reference period) when compared to the covered period. The text gives the following example: “a borrower reduced a full time employee’s weekly salary from $1,000 per week during the reference period to $700 per week during the covered period. The employee continued to work on a full time basis during the covered period. In this case the first $250 is exempted from the reduction. The borrower would list $400 as the salary/wage reduction for that employee ($50 per week additional reduction x 8 weeks)”
It is important to note that this reduction calculation is performed on a per employee basis and not in the aggregate. Also similar to the FTE exception the borrower can be exempt from the forgiveness reduction calculation if they eliminate the salary/wage reduction by June 30, 2020.
That’s the technical stuff. Apologies for the long winded email but we felt it was extremely important at this juncture given the passage of time since funding began. As always we are available to help you in this process in any way we can.
To download this article, click here.
Good luck and stay healthy
Partner and Staff LHF
L.H. Frishkoff & Company
546 Fifth Ave. New York, NY 10036
565 Taxter Road, Elmsford, NY 10523
L.H. Frishkoff & Company
546 Fifth Ave. New York, NY 10036
565 Taxter Road, Elmsford, NY 10523