Many businesses are relieved to have received PPP funds but are now concerned they may not receive forgiveness. The two primary causes for concern are: 1) not using the loan proceeds properly, and 2) not documenting the correct use of funds adequately. These are common concerns and we are here to help. Whereas we have received some guidance and information from the SBA and US Treasury Department, we await finalized guidelines. While we wait for the final rules, we wanted to help by sharing what we know now.
Please keep in mind that the information contained in this article is based on our current understanding. Even though we will be updating you with other PPP-related information as it because available, we ask that you do not solely rely on this information to make your financial decisions. It is best for you to engage legal counsel and advice from CPAs and other financial professionals. If you have specific questions, we would love to hear from you.
How Does Forgiveness for PPP Loans Work?
Below are the three primary source documents that summarize the entire program.
- The CARES Act
- The SBA’s PPP Interim Final Rule
- Supplement to the Interim Final Rule for self-employed borrowers
In summary, once your business is approved for the loan, the lender has 10 days to send you the money. All loan proceeds spent in the first eight weeks from the date that the money was distributed are eligible to be forgiven as long as they are used for approved expenses. To be fully forgiven, a minimum of 75% of the loan amount must be spent on payroll, and a maximum of 25% may be spent on utilities and business lease, rent, or mortgage payments.
Sometime after the eight-week period has passed, the lender will allow the borrower to apply for forgiveness. The lender will have up to 60 days to respond to the request for forgiveness. Because all principle and interest payments are deferred for the borrowers for the first six months, any unforgiven loan balances will be termed out for a period of 18 months at a 1% simple interest rate.
What are Forgivable Business Expenses?
The CARES Act specifically defines four categories of covered costs below:
1. Payroll Costs:
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- Salary, wages, commissions or similar compensation,
- Payment of cash tips or equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate of such tips),
- Payment for vacation, parental, family, medical, or sick leave;
- Allowance for dismissal or separation;
- Payment required for the provisions of employee benefits including insurance premiums;
- Payment of any retirement benefit;
- Payment of State or local tax assessed on the compensation of employees; plus
- For sole proprietors or independent contractors, wages, commission, income, or income from net earnings from self-employment, or similar compensation.
Payroll costs do not include:
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- The compensation of an individual employee in excess of an annual salary of $100,000, as prorated for the covered period;
- Federal employment taxes imposed or withheld between February 15, 2020, and June 30, 2020, including the employee’s and employer’s share of FICA (Federal Insurance Contributions Act) and Railroad Retirement Act taxes, and income taxes required to be withheld from employees;
- Any compensation of an employee whose principal place of residence is outside the United States;
- Qualified sick and family leave wages for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act.
- Also, note that payments to independent contractors are not covered by payroll. Independent contractors should apply for PPP on their own.
2. Rent, Mortgage
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- 2020. Covered mortgage is a debt “incurred in the ordinary course of business that is a liability of the borrower; is a mortgage on real or personal property; and was incurred before February 15, 2020. This also includes “rent payments on lease agreements in force before February 15, 2020” but relates to business real estate rent—not rent or lease payments on equipment, for example.
3. Utilities
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- A “covered utility payment” means payment for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020;
4. Interest on Covered Loan Obligations
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- Section 1106 of the CARES Act state that interest on a covered loan obligation is, “Any payment of interest on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation). The Term “covered mortgage obligation” means any indebtedness or debt instrument incurred in the ordinary course of business that—
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- is a liability of the borrower;
- is a mortgage on real or personal property; and
- was incurred before February 15, 2020”
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- The SBA has not explicitly provided enough clarification and verification on the forgiveness eligibility of interest paid on covered loan obligations for us to definitively state what is eligible or not, but our current understanding and interpretation is that this is a fourth use-type of approved expenses that should be eligible for forgiveness. We await further guidance on this subject.
Forgiveness Differences for the Self-Employed
we encourage all self-employed to read the full guidance released specifically for them by the SBA. That guidance states that “the amount of loan forgiveness can be up to the full principal amount of the loan plus accrued interest.” The actual amount of loan forgiveness will depend, in part, on the total amount spent over the covered period on business expenses.
What happens if payroll is spent on employees that get terminated or furloughed?
One of the primary reasons the entire loan may not be fully forgiven is because employers will either: 1) reduce the number of employees; or 2) reduce salary/wages.
Remember that the purpose of the PPP loans is to help keep employees employed and paid. Therefore, if a business reduces headcount or wages, their forgiveness will be partially jeopardized. The CARES Act states that “the average number of full-time equivalent (FTE) employees shall be determined by calculating the average number of FTE employees for each pay period falling within a month.” Then the business can choose to divide that number by either:
- The average number of FTE employees per month employed by the eligible recipient during the period beginning on February 15, 2019, and ending on June 30, 2019; or
- The average number of FTE employees per month employed by the eligible recipient during the period beginning on January 1, 2020, and ending on February 29, 2020; or
- In the case of a…seasonal employer (as determined by the Administrator) the average number of FTE employees per month employed by the eligible recipient during the period beginning on February 15, 2019, and ending on June 30, 2019.
You then multiply the amount eligible for forgiveness by that result. Here’s how we understand it to work: you have 9 FTE employees during the covered period but before that (based on one of the other periods bulleted above) you had 10 FTE employees. 9 / 10 = .9. Let’s say then you had $100,000 in PPP funds eligible for forgiveness including payroll, rent, and utilities. You multiply $100,000 by .9 and you now have $90,000 worth of PPP loan funds eligible for forgiveness. If this is confusing, give us a call or wait for the final guidance from the SBA.
Forgiveness will be reduced (pro-rata) if wages/salaries are reduced for an employee by more than 25% compared to their compensation for the full 3-month period immediately before February 15, 2020. Albeit confusing, the CARES Act states, “the amount of loan forgiveness…shall be reduced by the amount of any reduction in total salary or wages of any employee [who did not receive, during any single pay period during 2019, wages or salary at an annualized rate of pay in an amount more than $100,000] during the covered period that is in excess of 25 percent of the total salary or wages of the employee during the most recent full quarter during which the employee was employed before the covered period.”
How Does Rehiring Work?
The CARES Act includes a rehiring provision for employers who had to lay off or cut pay for workers between February 15, 2020, and April 26, 2020. For businesses who did that but restore the employees or wages by June 30, 2020, then there is an exemption to the reduction. We are looking forward to more guidance to come.
What Documentation Is Needed to Apply for Forgiveness?
We advise all businesses to carefully and transparently document their PPP loan uses—both for use during the forgiveness application, but also for the future in case the government decides to audit any past borrower. The SBA does not accept stories, explanations, or excuses—only evidence. The CARES Act states that borrowers applying for forgiveness must submit documentation verifying the number of FTE employees on payroll and pay rates for the periods, including:
- Payroll tax filings reported to the Internal Revenue Service; and
- State income, payroll, and unemployment insurance filings;
- Documentation, including canceled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments;
- A certification (stating) that—
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- The documentation presented is true and correct; and
- The amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, or make covered utility payments;
Forgiveness Includes Employment Taxes
The SBA stated, “Under the [CARES] Act, payroll costs are calculated on a gross basis without regard to (i.e., not including subtractions or additions based on) federal taxes imposed or withheld, such as the employee’s and employer’s share of Federal Insurance Contributions Act (FICA) and income taxes required to be withheld from employees. As a result, payroll costs are not reduced by taxes imposed on an employee and required to be withheld by the employer, but payroll costs do not include the employer’s share of payroll tax.”
For example, an employee who earned $4,000 per month in gross wages, from which $500 in federal taxes was withheld, would count as $4,000 in payroll costs. The employee would receive $3,500, and $500 would be paid to the federal government. However, the employer-side federal payroll taxes imposed on the $4,000 in wages are excluded from payroll costs under the statute.
Continental Bank cannot provide legal, tax, or accounting advice. You should consult your own counsel, accountant and other advisors to evaluate your individual facts and circumstances in connection with your PPP loan and the forgiveness process. This information is accurate and updated to the best of our knowledge as of 5.11.2020. Terms and conditions are subject to change.
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