SBA Issues New PPP Loan Forgiveness Applications and Guidance
The Small Business Administration (the “SBA”) last week issued a new Interim Final Rule on PPP loan forgiveness (the “Update Forgiveness IFR”) and provided two new Loan Forgiveness Applications. For the most part, these new publications implement the changes made by the PPP Flexibility Act (see Trenam Alerts: “What Will The Paycheck Protection Program Flexibility Act Mean For Your PPP Loan?” and “SBA Updates Guidance Under the PPP Flexibility Act“). The Update Forgiveness IFR and the instructions to the new Loan Forgiveness Applications answer many of the open questions, but a few questions remain unanswered. This Alert will summarize much of what we now know about the loan forgiveness process.
Two Key Items
Availability of Lender’s Portal
First, even if a borrower determines that it would be beneficial to use the optional eight-week (56-day) “covered period” (rather than the default 24-week “covered period” that was added by the PPP Flexibility Act), the end of the eight-week covered period may not be a signal that the Loan Forgiveness Application can be filed right away. These applications are required to be filed electronically through the particular lender’s portal and the portal for a particular borrower’s lender might not yet be ready to accept applications. Thus, a borrower first should check with its lender before completing its Loan Forgiveness Application.
Loan Forgiveness Application – Qualifying for the EZ Form
Second, the SBA actually issued two separate alternative Loan Forgiveness Applications, a new simplified one-page Form 3508EZ (the “EZ Application”) and the regular updated Form 3508 (the “Regular Application”).
The EZ Application is only available for use by a borrower who either:
- Is self-employed or a sole proprietor (i.e., files a Form 1040 Schedule C or Schedule F) who either (a) has never had any employees, or (b) had no employees at the time of filing the PPP loan application and did not include any employee salaries in the calculation of the average monthly payroll on its application (Form 2483).
- Is any other borrower who did not reduce annual salary or wages of any employee by more than 25% during the borrower’s “covered period” (or “Alternative Payroll Covered Period,” if applicable), as compared to the period between January 1, 2020 and March 31, 2020. For this purpose, the term “employee” does not include any employee who, during any single pay period during 2019, received annualized wages or salary in excess of $100,000. If the borrower is able to meet the foregoing condition, then it also must meet one of the following to qualify for use of the EZ Application:
- during the period between January 1, 2020 and the end of the borrower’s “covered period” (or “Alternative Payroll Covered Period,” if applicable), the borrower did not reduce its employee head count (for this purpose, an employee can be excluded from the head count if such person was employed on February 15, 2020, was subsequently laid off and the borrower is unable to rehire that individual or a similarly qualified person on or before December 31, 2020, or if an employee whose hours were reduced is offered a restoration of hours and refuses the offer); or
- during the period between February 15, 2020 and the end of the borrower’s “covered period” (or “Alternative Payroll Covered Period,” if applicable), the borrower was unable to operate at the same level of business activity as it did before February 15, 2020, because of compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020 by the Secretary of Health and Human Services, the director of the Centers for Disease Control and Prevention or the Occupational Safety and Health Administration related to the maintenance of standards of sanitation, social distancing, or any other work or customer safety requirements related to COVID-19.
- Observation: Essentially, the EZ Application is available for use by any borrower who or that did not reduce its employee head count or reduce salary/wage rates in a manner that would require the borrower to reduce the forgiveness amount for which the borrower is entitled.
- Observation: Curiously, the forgoing requirements for use of the EZ Application do not address whether an employee who is fired for cause or who voluntarily terminates employment can be excluded from the headcount for determining eligibility to use the EZ Application.
Other Issues of Note
For the most part, the SBA’s prior guidance, which was described in our previous Alerts, remains effective. Several issues of note were addressed in the Update Forgiveness IFR and the instructions to the EZ Application or the Regular Application, however, including the following items.
Clarification of the “60%/40% Rule
In our June 12th Alert, we stated the following:
“We will have to wait for additional SBA guidance to see whether “proportional limit” is construed to be the same as the original “75%/25%” rule that the SBA imposed (i.e., limiting total forgiveness to an amount equal to “payroll costs ÷ .60”) or whether it means a proportional reduction (i.e., reducing the total forgiveness amount by the percentage by which the borrower was below 60%, so that if the borrower only used 55% of the PPP loan proceeds for payroll costs, then its overall forgiveness amount would be reduced by 5/60, or 8.33%).”
The good news is that both the new EZ Application and the new Regular Application make it clear that the SBA will apply the same calculation as it used in the previous “75%/25%” rule, so that the total amount of loan forgiveness will be limited to an amount equal to “payroll costs ÷ .60.”
Election of the “Covered Period” and Impacts of That Election
One question that the new Loan Forgiveness Application answered was how a borrower is to make the election to use the eight-week (56-day) “covered period,” instead of using the new default 24-week “covered period” under the PPP Flexibility Act. Both the new EZ Application and the new Regular Application include a place for the borrower to make this election. Thus, the election is made on the Loan Application itself.
- Observation: Questions have been raised about whether a borrower can elect to use a “covered period” that is more than eight weeks but less than 24 weeks. For example, a borrower may not be able to exhaust all of the PPP loan proceeds on eligible expenses in eight weeks, but the proceeds can be used up in 16 weeks; so the question is whether the borrower could elect a 16-week covered period? The answer to this appears to be no. The PPP Flexibility Act set a hard default 24-week period, and thus there are only two options – accept the default 24-week period or make an election to use the eight-week alternative.
- Planning Opportunity: A rather technical argument, but a potential positive for borrowers, exists as a result of the change to a 24-week covered period. In the original CARES Act, the “covered period” for forgiveness was eight weeks, while the maximum amount of PPP loan proceeds to which a borrower was eligible was 2.5 times the average monthly payroll for the preceding twelve months. Under this formula, it was unlikely that a borrower would have payroll costs that exceeded its total PPP loan proceeds. Moving to a 24-week “covered period” changed this, however, and now an employer conceivably could have total payroll costs that exceed the PPP loan amount. Because of this, commentators expected that the SBA would amend the Loan Forgiveness Application to eliminate the ability of a borrower to use payroll costs that exceeded its PPP loan proceeds in the calculation of the forgiveness amount. The SBA did not make this change, however, so the opportunity currently is available to borrowers. Specifically, Line 11 of the Regular Application states that the “Forgiveness Amount” is “the smallest of lines 8, 9, and 10.” Line 8 is the modified amount determined after the reductions for salary/wages in excess of 25% and the FTE reduction, Line 9 is the total PPP loan amount, and Line 10 is the payroll cost limitation (i.e., payroll costs ÷ .60). To illustrate, consider the following example:
— PPP Loan amount of $1,000,000, received prior to June 5, 2020;
— Eight-week FTE reduction ratio of 90%;
— 24-week FTE reduction ratio of 60%;
— Eight weeks of eligible costs of $1,000,000, meeting the 60% payroll cost requirement (because the borrower continued to pay most of its staff to maximize forgiveness);
— 24 weeks of eligible costs of $2,000,000, meeting the 60% payroll cost requirement (because the borrower was not able to keep its full staff during the additional time, so only an additional $1 million was spent in the subsequent 16 weeks);
— There was no reduction in salary/wage rates in excess of 25% (so no forgiveness reduction based upon the salary/wage rate reduction factor); and
— Borrower does not qualify for any other relief from the FTE reduction.
If the borrower were to elect the eight-week “covered period,” then the loan forgiveness amount would be $900,000 [$1,000,000 x 90% FTE reduction factor), and the borrower would be required to repay $100,000 over two years (unless the borrower and lender were to agree to a five-year term). In contrast, if this borrower instead were to choose not to elect the eight-week “covered period” (so the 24-week “covered period” would apply automatically), then the result is actually a lower FTE count (because the borrower does not have the funds or business to retain the same level of staff), and a resultant increase in the FTE reduction factor; but amazingly, the borrower now will be forgiven the entire $1,000,000 PPP loan amount, because the limiting factor on forgiveness ($2,000,000 payroll costs ÷ .60) is $1.2 million. Although one might think that this does not make economic sense, a borrower should run this calculation before deciding whether this particular planning opportunity overrides the other benefits of electing the eight-week “covered period.”
Use PPP Loan Proceeds Properly, Even When Not Forgiven
If a borrower who obtained its loan before June 5, 2020 determines that the prudent approach is to elect the eight-week “covered period” and forgo some measure of forgiveness, the borrower still must remember that the PPP loan proceeds can only be used for eligible purposes (i.e., payroll costs and specified non-payroll costs). If the borrower knowingly uses PPP loan proceeds to pay costs that are not eligible, then “the federal government may pursue recovery of loan amounts and/or civil or criminal fraud charges.” Also, the borrower must give a certification that the borrower understands this in both the EZ Application and the Regular Application, so if this certification (which addresses the full amount of the PPP loan proceeds, not just the forgiven amount) is not accurate, then the SBA also would have grounds on which to deny forgiveness of any portion of the PPP loan.
Caps on Cash Compensation to Employees Making in Excess of $100,000 Annually and Owners
The Update Forgiveness IFR confirmed what was suspected, that the maximum cash compensation that can be counted during the 24-week “covered period” (or the 24-week “Alternative Payroll Covered Period”) for a non-owner employee earning more than $100,000 a year is $46,154. This is calculated by taking the 24-week period into account (24/52 x $100,000), and it is consistent with the calculation for the eight-week period (8/52 x $100,000 = $15,385).
The SBA, however, has taken a different approach for owner-employees and the self-employed (e.g., independent contractors, self-employed, or partners in a partnership). For these individuals, the SBA takes the position that the maximum compensation replacement that can be counted for forgiveness purposes during the 24-week “covered period” (or the 24-week “Alternative Payroll Covered Period”) is 2.5 months’ worth of 2019 compensation. Based upon this position, the maximum amount that can be taken for forgiveness purposes is determined based upon months, not weeks, resulting in a maximum amount of 2.5/12 months x $100,000, or $20,833. The Update Forgiveness IFR also notes that this maximum is an aggregate for all of the businesses in which the person is involved (under the SBA’s aggregation rules). This calculation is consistent with using 2.5 months of compensation to determine the amount of PPP loan proceeds for which a borrower was eligible. It is inconsistent, however, with the method of calculation for the eight-week “covered period” (or the eight-week “Alternative Payroll Covered Period”), which remains at $15,385 (this sum being calculated based upon weeks – 8/52 x $100,000). The SBA does not explain this discrepancy.
- Observation: The effect of the SBA’s position is that, for an owner-employee who has no other employees, the calculation of the PPP loan amount for which the owner-employee or self-employed person was eligible and the maximum forgiveness amount will be the same, so the person will be assured of full forgiveness of his or her PPP loan. Of course, full forgiveness would not occur if an owner employee or self-employed person paid W-2 wages in 2019 that were included in the PPP loan amount, but those wages are not paid during the 24-week “covered period” (or “Alternative Payroll Covered Period”), and so would not be eligible for forgiveness.
Other Changes Affecting Owner-Employees and Self-Employed
Several other changes affecting owner-employees and self-employed persons can be found in the instructions to both the EZ Application and the Regular Application, including the following:
- Several provisions of the instructions appear to include a shareholder in an S corporation as part of those who are considered an “owner-employee.” Until this language was included, it appeared that “owner-employees and the self-employed” were limited to those who file their business tax consequences on Form 1040, Schedules C and F. The language in the instructions, however, is not so limited. Without further guidance, this expansion is not clear; but the SBA certainly appears to be leaning in that direction. Of course, this raises another question, which remains unanswered – i.e., what percentage of ownership would be required to treat an S corporation shareholder as an “owner-employee”?
- Language in the instructions to the EZ Application appears to add a new limitation on the ability of a borrower to include employer contributions to retirement plans for owner-employees. The language first notes that contributions made on behalf of a self-employed individual or partner cannot be included, because these payments already are included in such person’s compensation. But, the provision goes on to say “contributions on behalf of owner-employees are capped at 2.5 months’ worth of the 2019 contribution amount.” This language is not included in the instructions to the Regular Application, so it is not clear if this is an intended change. If it is intended, then it is not clear how it should be interpreted, because retirement plan contributions often are made in arrears – i.e., the contributions made during 2019 likely related to the 2018 calendar year, while contributions made in 2020 likely relate to the 2019 calendar year. So, would this limitation apply to the 2018 contributions made in 2019, or does the limitation relate to the payments made in 2020 for 2019? This treatment also appears to be inconsistent with the calculation of the PPP loan amount on the original loan application (Form 2483), which allowed borrowers to receive a loan for cash compensation paid to owner-employees (subject to applicable limits) plus payments for retirement plan benefits. Further guidance will be needed if this change was intended and not just a mistake in the instructions to the EZ Application.
- Similarly, the instructions to Line 6 of the Regular Application, dealing with employer contributions for health insurance premiums seem to add a new rule for owner-employees. After stating that health insurance premiums paid on behalf of a self-employed person or partner cannot be included, the language goes on to exclude such premiums for “owner-employees of an S-corporation, because such payments are already included in their compensation.” Although this language might make sense in the context of a 2% or more shareholder in an S corporation (because premiums paid on their behalf are not deductible), it has a consequence that was not foreseeable before the addition of this language. Specifically, it would require the borrower to include the employer contributions for health insurance on Line 9 of the Regular Application, for owner compensation. This line is limited to $15,385 (for an eight-week covered period) or $20,833 (for a 24-week covered period). This language seems to be contrary, however, to the SBA’s FAQ #7, which states that “payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums” is not subject to the $100,000 annual cap on cash compensation. This treatment also appears to be inconsistent with the calculation of the PPP loan amount on the original loan application (Form 2483), which allowed borrowers to receive a loan for cash compensation paid to owner-employees (subject to applicable limits) plus premiums for health insurance. Thus, we will need further guidance from the SBA to know whether this language is intended to add a new limitation on owner-employees.
- Observation: Both the EZ Application and the Regular Application require the borrower to certify the following:
“The dollar amount for which forgiveness is requested: . . . if a 24-week Covered Period applies, does not exceed 2.5 months’ worth of 2019 compensation for any owner employee or self-employed individual/general partner, capped at $20,833 per individual; and if the Borrower has elected an 8-week Covered Period, does not exceed 8 weeks’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner, capped at $15,385 per individual.”
This language is ambiguous and difficult to understand, but it is additional evidence that, for owner-employees (which appears to include shareholders in S corporations and C corporations, although we still do not know what the percentage of ownership threshold is for an “owner-employee”), the SBA is taking the position that the total “payroll costs” – not just cash compensation, but also retirement plan contributions and health insurance premiums – are included in the cap of $20,833 or $15,385. This is contrary to the express language of the CARES Act, but it appears to be the position that the SBA is taking.
As with virtually all of the guidance that the SBA has published to date on the Paycheck Protection Program, we get answers to many questions, but other questions either remain unanswered or are raised by the new guidance. Stay tuned until we hear more.
If you have any questions regarding how the Update Forgiveness IFR or the new Loan Forgiveness Applications impact your PPP loan planning, please feel free to contact any member of Trenam Law’s COVID-19 Relief Programs Team.