ppp loan forgiveness

By: sal schibell, lawson, rescinio, schibell & Assoc.

Paycheck Protection Program Loans and Loan Forgiveness

If your small business was slammed by the COVID-19 crisis, you can obtain a paycheck protection program loan (PPE loan) that is equal to 2.5 times your monthly payroll under Section 1106 of the CARES Act. If your monthly payroll runs $40,000, for example, your PPP loan amount might be $100,000. The calculated value of payroll includes not just wages but also employee benefits, state payroll taxes, and the business owner compensation replacement. What’s more, if you spend the loan proceeds on payroll, rent, interest, and utilities within eight weeks, the Small Business Administration forgives the loan. However, the following situations will limit your loan forgiveness:

Headcount Reduction

According to Section 1106(d)(2)(A) of the CARES Act, reducing your workforce results in an equivalent reduction in loan forgiveness. This adjustment works simply; the amount eligible for forgiveness decreases by the percentage of full-time equivalent employees that you lose. Say you employed five full-time employees and ten halft ime employees last year. Converted to full-time equivalent employees, you employed 10 workers. If you terminate two full-time workers, your count of full-time equivalent employees drops from 10 to 8 workers. This represents a 20% cut in headcount, which would reduce the initial amount eligible for forgiveness by 20%. If your firm had spent a total of $100,000 on payroll, interest, rent, and utilities, but you reduced your headcount by 20 percent, your loan amount drops by 20 percent to $80,000.

One thing to note: businesses can choose which period of employment is used to calculate a reduction in workers. A firm can compare its current employment to employment from February 15, 2019 through June 30, 2019 or from January 1, 2020 through February 29, 2020.

Pay Rate Reductions

After the formula adjusts the initial amount eligible for forgiveness based on headcount, it looks for any reductions in employee pay rates in excess of 25%. Section 1106(d)(d)(A) details this adjustment. Note that the formula ignores pay rate reductions for employees who earned more than $100,000 on an annualized basis in 2019. For everyone else, a pay rate reduction in excess of 25% is subtracted from the amount available for forgiveness. Suppose a firm reduces the pay rate for one employee from $8,000 to $2,000. Perhaps this employee earns a sales commission, and the bad economy cuts sales for a few months. That 75% decrease in payroll (from $8,000 to $2,000) equals $6,000. A 25% decrease in payroll would be $2,000, so the reduction in pay rate in excess of 25% equals $4,000. Thus the amount eligible for forgiveness decreases by an equivalent $4,000.

In review, if a small business started out with an initial amount eligible for forgiveness of $100,000, a 20% reduction in headcount might reduce that $100,000 to $80,000, and the subsequent pay rate reduction would subtract another $4,000, bringing the total amount eligible for forgiveness to $76,000.

Missing the Rehire Window of Opportunity

The Section 1106 statute includes a couple of mulligans. The first? Per the statute and a forthcoming interim final rule, if a firm either rehires or attempts to rehire employees who were laid off between February 15, 2020 and April 29 ,2020, it avoids a reduction in the initial amount eligible for forgiveness due to an earlier reduction in your headcount. To avoid this reduction, a firm needs to rehire the employee by June 30. The firm needs to make "a good faith written offer" to rehire the same employee at the same pay rate and for the same number of hours and then document the employee's rejection.

Note, however, that even if a firm avoids this headcount reduction by rehiring or attempting to rehire, it will still calculate a smaller initial amount eligible for forgiveness. For example, say a firm averages $40,000 a month in payroll during 2019. As a result, it receives a $100,000 loan. Assume, however, that the firm laid off its entire workforce before receiving the PPP loan and can't rehire them until June 30. Because the firm rehires employees by June 30, it avoids the headcount reduction adjustment, but without employees on the payroll during April, May, and June, it lacks payroll costs to plug into the initial amount eligible for forgiveness.

Missing the Pay Cut Reversal Window of Opportunity

If a firm reverses a reduction in salaries or wages by June 30, that reversal eliminates the requirement to reduce loan forgiveness eligibility based on pay rate cuts in April, May, and June. Again, though, note that the pay rate cuts reduce the payroll cost that plugs into the formula. For example, suppose a firm with

ten employees making $1,000 a week cuts wages to $500 a week. If the employer reverses the wage cuts by June 30, the wage cut adjustment doesn't need to be calculated. The firm doesn't need to calculate that a $500 per worker reduction is $250 more than a 25% decrease and it doesn't need to tally up these excess wage reductions and subtract the total from the initial "eligible for forgiveness" amount. However, the initial 50% cut in wages means the firm pays 50% less payroll.

Bad Documentation

Tax accountants will tell you that taxpayers often lose audits only because they lack good documentation. Something similar, surely, will happen with the PPP loans. The statute requires a borrower to provide rich, detailed, and high-quality documentation. Here is an abbreviated list of application requirements from Section 1106(1-4):

• Payroll tax filings reported to the Internal Revenue Service

• State income, payroll, and unemployment insurance filings

• Documentation, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments

• Any other documentation the Administrator determines is necessary.

Mark my words, many small business owners won't be able to provide this detail. And in that case, the statute says they lose forgiveness. In the words of Section 1106(F) of the law, "no recipient shall receive forgiveness without submitting the documentation required."

One other thing to consider about documentation: the Section 1102 statute (the main law that creates the paycheck protection program) requires you to use the PPP funds for approved purposes. It is very possible that some small businesses will spend enough money on the appropriate expenses (payroll, rent, interest and utilities), but then lack the ability to prove the PPP loan funds provided the money that was spent.

The 25% Non-Payroll-Costs Rule

The statutes passed by Congress explain you can receive forgiveness if you spend the money on payroll, rent, interest, and utilities, but the Treasury and the Small Business Administration refined this in the Interim Final Rule to say that non-payroll costs can't represent more than 25% of the loan forgiveness amount. You can read this requirement two ways, but the friendly way to read this rule goes like this:

You received a $100,000 loan. Due to state mandated closures, you could only spend $60,000 on payroll during the eight weeks the PPP loan forgiveness formula considers. You also spent $40,000 on rent, interest, and utilities. You might think you're okay in this situation, but you won't get forgiveness for the entire $100,000 even though your spending seems to be a valid use of the PPP loan funds. Instead, you will be limited to forgiveness for only half of the $40,000 you spent on rent, interest, and utilities. Why? Because with forgiveness for rent, interest, and utilities capped at 25%, $60,000 of forgiveness for payroll would only allow $80,000 of forgiveness total and $20,000 on other qualified expenses ($60,000/.75=$80,000).

Failing to Spend at Least 75% on Payroll-Costs Rule

Scattered through the Interim Final Rule is the repeated phrase the phrase "at least 75 percent of the PPP loan proceeds shall be used for payroll costs.“ What this means isn't clear to me. Is this the same thing as what I describe in above or does this mean something different? For example, does it mean that if you borrow $100,000 but then only spend $60,000 on payroll costs, you lose forgiveness? I flip-flop in my assessment of this, but you probably want to consider the possibility you lose forgiveness in this situation.

If you read through the Interim Final Rule, the language seems clear: “the Administrator believes that the finite appropriations and the structure of the Act warrant a requirement that the borrowers use a substantial portion of the loan proceeds for payroll costs, consistent with Congress' overarching goal of keeping workers paid and employed." This discussion then goes on and makes the statement that the Secretary of the Treasury and the Small Business Administrator have decided that "75 percent is the appropriate percentage." Further, the discussion notes that this limitation on the use of funds "will help ensure that the finite appropriations available for these loans are directed toward payroll protection."

Here’s where the harsh reading of the 75% rule comes in. Within the Interim Final Rule, two deceptively similar statements appear in proximity. First, no more than 25% the loan proceeds may be used for non-payroll costs. Second, no more than 25 percent of the forgiven amount may be for non-payroll costs. I don't believe that these two statements are equivalent. Accordingly, I will not be surprised if spending less than 75 percent on payroll eliminates the forgiveness.

A Tip Related to a Harsh Reading of the 75 Percent Rule

If you inadvertently received a PPP loan much larger than you should have, stay especially alert. Say, for example, that your PPP loan application erroneously treated amounts paid to 1099 independent contractors as wages. People understandably made this mistake. Early guidance lacked clarity. In this case, however, you received a far larger loan than you should have, and you may find it impossible to spend 75 percent or more on payroll.

I'm not sure what you do about this. Perhaps consider hiring your contractors? Or maybe you want to return the loan? Or maybe you just want to plan to repay the loan? What a mess, right?

Self-Employed Folks Counting on Full Forgiveness

A self-employed Schedule C business without employees apparently receives only partial forgiveness of a PPP loan. Here’s the complete language from the Additional Eligibility Criteria Interim Final Rule:

“For individuals with self-employment income who file a Schedule C, the Administrator, in consultation with the Secretary, has determined that it is appropriate to limit loan forgiveness to a proportionate eight-week share of 2019 net profit, as reflected in the individual's 2019 Form 1040 Schedule C. This is

because many self-employed individuals have few of the overhead expenses that qualify for forgiveness under the Act. For example, many such individuals operate out of either their homes, vehicles, or sheds and thus do not incur qualifying mortgage interest, rent, or utility payments. As a result, most of their receipts will constitute net income. Allowing such a self-employed individual to treat the full amount of a PPP loan as net income would result in a windfall. The entire amount of the PPP loan (a maximum of

2.5 times monthly payroll costs) would be forgiven even though Congress designed this program to limit forgiveness to certain eligible expenses incurred in an eight-week covered period. Limiting forgiveness to eight weeks of net profit from the owner's 2019 Form 1040 Schedule C is consistent with the structure of the Act, which provides for loan forgiveness based on eight weeks of expenditure” (85 Fed. Reg. 21750).

To illustrate this, if your 2019 Schedule C shows exactly $52,000 of profit, you earned $4,333 a month and $1,000 a week. Your loan equaled 2.5 times $4,333 or $10,833, but forgiveness equals eight times $1,000 or $8,000.

A Closing Comment

To my way of thinking, you want to uncouple the PPP loan from the forgiveness formula. Think about the loan as a loan, pure and simple. If you need a loan, the PPP loan works great, except for the goat rodeo element to applying. Other than that, the PPP loan may provide inexpensive flexible financing that helps you get through an almost unimaginably rough patch. The forgiveness, though? Consider that icing on the cake. If you get some or a bunch of forgiveness? Great. Count yourself fortunate. But don't bank on it.