The SBA Issues New FAQs on PPP Loan Forgiveness
After a hiatus of over a month, on August 4, 2020, the Small Business Administration (the “SBA”) issued a new set of Frequently Asked Questions (the “New FAQs”). Unlike its previous FAQs (the last of which were issued on June 25th), which were a compendium in no particular order of all previous and new questions and answers, the New FAQs are logically grouped into topics relating to forgiveness, including General Questions, Payroll Costs, Nonpayroll Costs and Forgiveness Reductions. Much of the information in the New FAQs is not new, but the SBA does clarify its thinking on some issues and adds clarity on how to report various items on the Loan Forgiveness Application (SBA Form 3508, Form 3508EZ or lender equivalents).
The following is not intended to be a summary of everything in the New FAQs (which can be found here), but rather will highlight the additional information and clarifications. For ease of using this Alert along with the New FAQs, this Alert follows the general topic headings of the New FAQs.
General Loan Forgiveness FAQs
We recently were involved in a purchase transaction where the purchaser was unwilling to deal with an outstanding PPP loan of the seller, even though the seller was ready to file its Loan Forgiveness Application and had a well-documented argument for full forgiveness (but is waiting for its lender’s portal to open to file the application). As a result, the purchaser took a hard line and demanded that the seller repay the PPP loan and accrued interest in full, ignoring the potential for all or a portion of the PPP loan and accrued interest to be forgiven and refusing to address the risk by setting up a separate escrow of a portion of the purchase price.
We also have received inquiries from clients who are not involved in a purchase transaction, asking whether they will need to start to repay their PPP loans before the SBA determines the amount to be forgiven.
Although the SBA has not taken away all risk in this regard (because there is no way to know in advance how much of the PPP loan the SBA ultimately will agree can be forgiven), the SBA has addressed these issues in the New FAQs by stating the following:
“As long as a borrower submits its loan forgiveness application within ten months of the completion of the Covered Period . . . , the borrower is not required to make any payments until the forgiveness amount is remitted to the lender by SBA. If the loan is fully forgiven, the borrower is not responsible for any payments. If only a portion of the loan is forgiven, or if the forgiveness application is denied, any remaining balance due on the loan must be repaid by the borrower on or before the maturity date of the loan. Interest accrues during the time between the disbursement of the loan and SBA remittance of the forgiveness amount. The borrower is responsible for paying the accrued interest on any amount of the loan that is not forgiven. The lender is responsible for notifying the borrower of remittance by SBA of the loan forgiveness amount (or that SBA determined that no amount of the loan is eligible for forgiveness) and the date on which the borrower’s first payment is due . . . .”
- Observation: For a borrower who is concerned about filing its Loan Forgiveness Application before payments on its PPP loan become due, this paragraph provides a fair amount of comfort. The borrower simply must be sure that its Loan Forgiveness Application is filed no later than the end of the tenth month after the end of the 24-week Covered Period (or after the end of the 8-week Covered Period, if that shorter period was elected). If any payments ultimately must be made on the PPP loan (i.e., less than the entire loan is forgiven), those required payments are deferred and will not start until after the forgiveness amount, if any, is determined. The balance then will be due before the maturity date of the PPP loan (i.e., either five years after the PPP loan was funded or, if the loan was funded before June 5, 2020, then two years after the initial loan funding date, unless the borrower and lender agree to a five-year maturity).
- Observation: In a purchase transaction, the seller may be able to provide sufficient evidence to the purchaser as part of the due diligence process to get the purchaser comfortable that the seller will successfully obtain forgiveness, so that all that will be necessary will be appropriate representations and warranties relating to the PPP loan. Alternatively, the parties can negotiate to hold a part or all of the PPP loan liability in escrow (using proceeds, if available, that otherwise are payable by the purchaser to the seller) pending a final decision on forgiveness by the SBA. If the entire loan is forgiven, then the escrowed sum would be released from escrow and paid over to the seller. If only a part or none of the PPP loan is forgiven, then the escrowed funds will be available to satisfy the unforgiven portion of the PPP loan (with any remaining amount, if any, being released from escrow and paid over to the seller).
- Warning: It is not clear what the effect is of a borrower paying off its PPP loan prior to the SBA’s determination on forgiveness. It is clear from the instructions to lenders that the lender must indicate the pay-off on the borrower’s loan file, which is given to the SBA. If a pay-off occurs prior to the submission of a Loan Forgiveness Application, then it is possible that the pay-off will preclude the submission of the application. Likewise, if a borrower pays off the loan after submission of its application, it is possible that the SBA will not consider the application (or treat it as having been withdrawn). Thus, if the seller chooses to pay off the PPP loan in order to placate the buyer and close the purchase, it is possible that the seller would not then be able to seek forgiveness (to recover what it already had paid).
Loan Forgiveness Payroll Costs FAQs
A number of items were clarified under this topic, including the following:
When can a borrower use the Alternative Payroll Covered Period and use only full pay periods to calculate its payroll costs? A borrower whose payroll period is bi-weekly or more frequent can elect to use either:
1) the Covered Period (i.e., the 24-week or 8-week period commencing on the date that the PPP loan proceeds are received), in which case the borrower can use payroll that was incurred prior to the start of the Covered Period but is paid during the Covered Period (getting the use of up to an additional two weeks of payroll to apply to forgiveness); or
2) the Alternative Payroll Covered Period (i.e., the 24-week or 8-week period commencing on the first day of the payroll period that starts after the PPP loan proceeds were received), which will allow the borrower to use full pay periods in its calculation of payroll costs to apply to loan forgiveness.
In contrast, if a borrower pays its payroll on a twice a month or less frequent schedule, then it can only use its Covered Period, and it must calculate payroll costs for partial pay periods. It still would be able to include payroll incurred prior to the Covered Period but paid during the Covered Period, but it can only include in its last pay period the portion of that period that ends on the last day of the Covered Period.
What payments to employees can be included in payroll costs? The borrower can include salaries, wages, payments made to make up lost tips or lost commissions, bonuses and any other cash compensation, as long as, in total, the employee is not paid a gross sum (before reduction for any FICA taxes or income tax withholding) during the 24-week or 8-week period that, when annualized, is more than $100,000.
What health insurance and retirement plan benefits can be included in the forgiven payroll costs? The SBA clarified that only employer-paid health insurance premiums or costs and retirement plan contributions or similar benefits may be included in the payroll costs for calculating the forgiveness amount, and employee-paid sums are not allowed. In addition, the SBA made it clear that forgiveness will not be given for PPP loan proceeds used to pay expenses that are accelerated from periods outside the Covered Period or Alternative Payroll Covered Period. Thus, contrary to what many commentators understood, it is not possible to accelerate the payment of future health insurance premiums or costs or future retirement plan contributions/benefits to increase the payroll costs for the forgiveness calculation.
How are the sums allowed in the payroll costs of owner-employees, self-employed persons, partners and independent contractors determined? The SBA provided further clarification of what payroll costs are and how they are determined for these individuals. First, an “owner” is defined simply as “an owner who is also an employee.” Thus, there is no minimum amount of stock ownership that triggers this provision (except for owners of an S corporation, as noted below). As for the expenses that can be included, the SBA looks to how the person reports items on his or her individual income tax return. The New FAQs describe how to report these items on the Loan Forgiveness Application. Specifically, for forgiveness purposes, payroll costs attributable to these individuals include the following:
Corporations: A borrower can include 2.5/12 of the owner’s 2019 employee cash compensation (calculated the same as for all employees), up to a maximum of $20,833 (for a 24-week Covered Period) or $15,385 (for an 8-week Covered Period), plus the sums paid for health insurance and retirement benefits (not included in the $20,833/$15,385 cap), which non-cash compensation amounts are reported on Lines 6-8 of PPP Schedule A of the Loan Forgiveness Application.
S Corporations: A borrower can include 2.5/12 of the owner’s 2019 employee cash compensation (calculated the same as for all employees), up to a maximum of $20,833 (for a 24-week Covered Period) or $15,385 (for an 8-week Covered Period), plus 2.5/12 of the 2019 employer retirement plan contribution made on behalf of the owner (which is not included in the $20,833/$15,385 cap). Sums paid for health insurance benefits are not allowed for any owner of 2% or more of the stock of the S corporation (or any employee who is a family member of a 2% or more owner, because of the attribution rules under IRC § 318). The allowed non-cash compensation amounts are reported on Lines 7-8 of PPP Schedule A of the Loan Forgiveness Application.
Self-Employed (including Sole Proprietor and Independent Contractor): A self-employed person, sole proprietor or independent contractor may use 2.5/12 of his or her 2019 net profit as reported on IRS Form 1040 Schedule C, line 31, or net farm profit as reported on IRS Form 1040 Schedule F, line 34, in either case up to a maximum of $20,833 (for a 24-week Covered Period) or $15,385 (for an 8-week Covered Period). Separate payments for health insurance, retirement, or state or local taxes are not eligible for additional loan forgiveness. If the borrower did not submit its 2019 IRS Form 1040 Schedule C (or F) to the lender when the borrower initially applied for the PPP loan, he or she must include that with the borrower’s Loan Forgiveness Application.
General Partners: A borrower can include 2.5/12 of a general partner’s 2019 net earnings from self-employment that is subject to self-employment tax, which is computed on IRS Form 1065 Schedule K-1, box 14a (reduced by box 12, section 179 expense deduction, unreimbursed partnership expenses deducted on the partner’s IRS Form 1040 Schedule SE, and depletion claimed on oil and gas properties) multiplied by 0.9235, but only up to a maximum of $20,833 (for a 24-week Covered Period) or $15,385 (for an 8-week Covered Period). Compensation is only eligible for loan forgiveness if the payments to the partner are made during the Covered Period or Alternative Payroll Covered Period. Separate payments for health insurance, retirement plan contributions/benefits or state or local taxes are not eligible for additional loan forgiveness. If the borrower did not submit its 2019 IRS Form 1065 Schedule K-1s when initially applying for the PPP loan, then it must be included with the borrower’s Loan Forgiveness Application.
LLC owners: If a borrower is an LLC, then the amount of its owner’s compensation that can be included for forgiveness purposes is determined based upon how the LLC’s business was organized and elected to be taxed for federal tax filing purposes for tax year 2019, or if a new business, the expected tax filing situation for 2020, whether as an S corporation, partnership or sole proprietorship, as outlined above.
Loan Forgiveness Nonpayroll Costs FAQs
Can nonpayroll costs incurred prior to the Covered Period be used for forgiveness? Yes, nonpayroll costs are treated in the same manner as payroll costs for purposes of forgiveness. Thus, if mortgage interest, rent or utility payments are made during the Covered Period, those payments can be counted, even if the expense actually was incurred prior to the Covered Period. For example, if the Covered Period began on May 4, 2020, and on May 15th the borrower paid mortgage interest,. rent or utility bills (in each case relating to obligations or leases dated prior to February 15, 2020), those payments are eligible nonpayroll expenses, even if the payments relate to interest, rent or utility expenses incurred in April, prior to the Covered Period.
What other clarifications were made relating to nonpayroll costs?
- The Alternative Payroll Covered Period is not available for determining nonpayroll costs, even if the borrower uses the Alternative Payroll Covered Period for calculating its payroll costs. All nonpayroll costs must be paid during the Covered Period or be incurred during the Covered Period and paid on or before the next regular billing date following the end of the Covered Period.
- Only interest on secured loans (e.g., where real estate or personal property is pledged as collateral for the loan) is eligible as a nonpayroll expense for forgiveness purposes. The proceeds of a PPP loan may be used to pay interest on an unsecured loan incurred prior to February 15, 2020 under the CARES Act, but that interest is not eligible for forgiveness.
- If a secured loan or lease was in effect prior to February 15, 2020, then the interest or rent payment is eligible for forgiveness even if the loan is refinanced or the lease is renewed after February 15, 2020.
- The CARES Act also included as an eligible nonpayroll expense a “payment for the distribution of . . . transportation.” The SBA interprets this as “transportation utility fees assessed by state and local governments” (e.g., fees for local bus streetcar or light rail services).
Loan Forgiveness Reductions FAQs
What safe harbor exists from forgiveness reduction if a borrower reduced its FTE count during the Covered Period but offered to rehire one or more employees and the employees declined the offer? In earlier guidance, the SBA stated that a borrower could exclude an employee as an FTE reduction if the employer offered to rehire that employee and the employee declined the offer. However, the Paycheck Protection Program Flexibility Act of 2020 added a similar but much more limited safe harbor, and the SBA abandoned its previous guidance in favor of the language in the statute. As a result, in order to exclude an FTE reduction, the borrower now must document in good faith each of the following:
1) an inability to rehire individuals who were employees of the borrower on February 15, 2020;
2) an inability to hire similarly qualified individuals for unfilled positions on or before December 31, 2020; and
3) that the borrower informed the applicable state unemployment insurance office of any employee’s rejected rehire offer within 30 days after the employee’s rejection.
For this purpose, the borrower’s documentation should include the written offer to rehire an individual, written evidence of the person’s rejection, and written evidence of efforts to hire a similarly qualified individual. Unfortunately, the SBA still has not addressed what makes an individual “similarly qualified” or what constitutes an “inability to hire” (e.g., is the high cost of recruiting, the need to pay a higher salary to the potential replacement or the cost of moving the individual a valid reason for the “inability,” or will only rejection of offers suffice?).
When calculating the FTE Reduction Exceptions in Table 1 of the PPP Schedule A Worksheet on the Loan Forgiveness Application, does the borrower include employees who made more than $100,000 in 2019 (i.e., those listed in Table 2 of the PPP Schedule A Worksheet)? The exception for FTE reduction applies to all employees. Thus, all employees (including employees listed on Table 2) should be shown on Table 1 of the PPP Schedule A Worksheet.
What employees are included in the calculation of the salary/wage rate reduction? Only “covered employees” are included in this calculation. A “covered employee” is a person who (1) was employed by the borrower at any time during the Covered Period or Alternative Payroll Covered Period (as applicable) whose principal place of residence is the United States and (2) received compensation from the borrower at an annualized rate of less than or equal to $100,000 for all pay periods in 2019 or was not employed by the borrower at any time during 2019. Employees who were paid more than $100,000 at any time during 2019 are not included in this calculation.
How does a borrower calculate the loan forgiveness reduction for salary or wage rates on the Loan Forgiveness Application? The SBA provided several examples of how these calculations are to be made, including:
- A borrower received its PPP loan before June 5, 2020, and elected to use an 8-week Covered Period. The borrower reduced a full-time salaried employee’s salary during the Covered Period from $52,000 per year to $36,400 per year, and the salary is not restored by December 31, 2020. The employee continued to work on a full-time basis with a full-time equivalency (FTE) of 1.0. The borrower should refer to the “Salary/Hourly Wage Reduction” section under the “Instructions for PPP Schedule A Worksheet” in the instructions to the Loan Forgiveness Application. In Step 1, the borrower enters the figures in 1.a, 1.b, and 1.c, and, because annual salary was reduced by more than 25%, the borrower proceeds to Step 2. Under Step 2, because the salary reduction was not remedied by December 31, 2020, the Salary/Hourly Wage Reduction Safe Harbor is not met, so the borrower is required to proceed to Step 3. Under Step 3.a., the minimum salary that must be maintained to avoid a reduction is $39,000 (75% of $52,000), and, because the employee’s salary was reduced to $36,400, the excess reduction of $2,600 is entered in Step 3.b. Because this employee is salaried, in Step 3.e., the borrower would multiply the excess reduction of $2,600 by 8 (if the borrower instead had elected a 24-week Covered Period, then it would multiply by 24) and divide by 52 to arrive at a loan forgiveness reduction amount of $400. The borrower would enter on the PPP Schedule A Worksheet, Table 1, $400 as the salary/hourly wage reduction in the column above box 3 for that employee.
- A borrower received its PPP loan before June 5, 2020 and elected to use a 24-week Covered Period. The borrower reduced an hourly employee’s hourly wage during the Covered Period from $20 per hour to $15 per hour. The employee worked 10 hours per week between January 1, 2020 and March 31, 2020. The borrower should refer to the “Salary/Hourly Wage Reduction” section under the “Instructions for PPP Schedule A Worksheet” in the instructions to the Loan Forgiveness Application. Because the employee’s hourly wage was reduced by 25% or less (i.e., exactly 25%, from $20 per hour to $15 per hour), the wage reduction does not reduce the eligible forgiveness amount. The amount on line 1.c would be 0.75 or more, so the borrower would enter $0 in the Salary/Hourly Wage Reduction column for that employee on the PPP Schedule A Worksheet, Table 1. Instead, if the borrower had reduced the employee’s hourly rate to $14 per hour during the Covered Period, then the reduction would be more than 25%, so the borrower would proceed to Step 2. If that reduction is not restored by December 31, 2020, then the borrower would proceed to Step 3. The hourly wage reduction in excess of 25% is $1 per hour. In Step 3, the borrower would multiply $1 per hour by 10 hours per week to determine the weekly salary reduction. The borrower would then multiply the weekly salary reduction by 24 (because the borrower is using a 24-week Covered Period). The borrower would enter $240 in the Salary/Hourly Wage Reduction column for that employee on the PPP Schedule A Worksheet, Table 1. If the borrower applies for forgiveness before the end of the 24-week Covered Period, it must account for the salary reduction (the excess reduction over 25%, or $240) for the full 24-week Covered Period.
- An employee earned a wage of $20 per hour between January 1, 2020 and March 31, 2020 and worked 40 hours per week. During the Covered Period, the borrower reduced the employee’s weekly hours from 40 to 25 hours per week, but the employee’s hourly wage was not changed. In this situation, the salary/hourly wage reduction for that employee is $0, because the hourly wage was unchanged, so the borrower would enter $0 in the Salary/Hourly Wage Reduction column for that employee on the PPP Schedule A Worksheet, Table 1. However, the employee’s reduction in hours would be taken into account in the borrower’s calculation of its FTEs during the Covered Period, which is calculated separately and may result in a reduction of the borrower’s loan forgiveness amount.
- Observation: In the second example above, the comment is made that a borrower does not need to wait until the end of the Covered Period to file its Loan Forgiveness Application. This is most likely for a borrower who chooses to use the 24-week Covered Period but uses all of its PPP loan proceeds before the end of 24 weeks. We mentioned in a previous Alert that it might make sense for a borrower to file the loan forgiveness application early. However, if the borrower has not restored any salary/wage rate reduction(s) or FTE reduction(s) at the time of the early filing, then it must account for the full 24-week Covered Period in calculating its forgiveness reductions. On the other hand, it appears, but we still have no definitive guidance stating, that a borrower who has restored any salary/wage rate or FTE reductions at the time of filing its Loan Forgiveness Application will avoid any reduction, even if any salary/wage rate or FTE reductions are reinstituted (and not again restored) on or before December 31, 2020.
What compensation is taken into account in determining any forgiveness reduction for salary/wage rate reductions during the Covered Period that are not restored on or before December 31, 2020? SBA clarified that only salaries and wage rates are taken into account in calculating the forgiveness reduction. Thus, reductions in bonuses, commissions, lost tips or benefits that otherwise constitute “payroll costs” for purposes of forgiveness are not taken into account
As mentioned above, there remain a number of unanswered questions on forgiveness. We hope that the SBA will continue to add guidance during this difficult process. Stay tuned!
If you have any questions regarding the New FAQs or the forgiveness process, please feel free to contact any member of Trenam Law’s COVID-19 Relief Programs Team.