What You Need to Know After You Receive Your Paycheck Protection Program Loan
You are not alone if you are confused about how to track your use of and how to calculate the amount of forgiveness for which you will qualify on your Paycheck Protection Program (“PPP”) loan. The Small Business Administration (the “SBA”) provided some guidance in its Interim Final Rules and the FAQs that were issued thereafter, but many questions remain. The following will give you some of the answers, based upon the available information, and we will provide an update if and when the SBA provides additional guidance.
A. What are the applicable time periods and dates that you need to know?
The CARES Act provides several different definitions of “covered period” that apply for different purposes, and other dates are mentioned in the CARES Act that also are important. These include:
February 15 – June 30, 2020: The period during which PPP loan proceeds must be used to pay for expenses (the “Use Covered Period”). This implies that PPP loan proceeds may properly be used for expenses that were incurred before the loan was issued, so you can reimburse yourself for expenses incurred after February 15, 2020. See below, however, for what PPP loan proceeds may be forgiven.
Eight-week period after the PPP loan is funded: The period during which eligible payments are incurred and paid that count in calculating your PPP loan forgiveness (the “Forgiveness Covered Period”). Note that, although reimbursing yourself for eligible expenses incurred during the Use Covered Period may be allowed under the CARES Act, you will not receive forgiveness for these payments, because they were not incurred and paid during the Forgiveness Covered Period.
February 15 – April 26, 2020: If, during this period (the “Forgiveness Reduction Comparison Period”), there is either: (1) a reduction in the number of your full-time equivalent employees (“FTEs”) , as compared to the number of FTEs on February 15, 2020, or (2) there is a reduction of more than 25% of the compensation paid to one or more employees as compared to the compensation paid on February 15, 2020, then your forgiveness amount will be subject to reduction. See below for what this means and how to avoid it.
There are many questions raised in the use and calculations arising from these time periods, including how is “full time equivalent” determined? We hope that the expected SBA guidance will address these questions, and more.
B. What may the PPP loan proceeds be used for, and what is the consequence of using proceeds for an ineligible purpose?
The eligible uses of the PPP loan proceeds include the following:
- Payroll Costs, which means salaries and wages paid to employees whose primary residence is in the United States, but for each employee, only up to a maximum of $100,000 annually ($8,333.33 per month), and excluding the employment and income taxes withheld from employees’ compensation (i.e., figured on “gross pay”) and the employer‘s portion of employment taxes. One open question here is what is an “employee” (e.g., what about a terminated employee? Severance payments are included as a “Payroll Cost,” so it is likely that terminated employees would be included, but we will need to see if the SBA issues guidance on this);
- Other employee salaries, commissions, tips or similar compensation (no definition of this);
- Benefits paid on behalf of employees, without regard to the $100,000 per employee cap on the compensation paid to any of these employees, including vacation, parental, family, medical, or sick leave, costs of group health insurance (including insurance premiums you pay) and payments for retirement benefits (the term “retirement benefit” is not clear, except the SBA’s Interim Final Rule defines it as defined benefit and defined contribution retirement plans);
- Interest (not principal or any prepayments of principal or interest), but only on mortgage loans that were incurred prior to February 15, 2020;
- Rent paid on leases, but only on leases entered into prior to February 15, 2020;
- Utility charges paid, but only on utility services that were for utilities in place on February 15, 2020; and
- Interest (not principal) on unsecured debt (e.g., a line of credit), but only on unsecured debt that was incurred prior to February 15, 2020.
Although not included in the CARES Act, the SBA has ruled that at least 75% of the loan proceeds must be used for payroll purposes. Thus, if more than 25% of the PPP loan proceeds are used for non-payroll purposes, this would be an ineligible use.
Using the PPP loan proceeds for any other purpose, including for rent, utilities or debt in excess of 25% of the PPP loan, for rent, utilities or debt on contracts entered into after February 15, 2020, for compensation that is not allowed, or any incorrect certifications listed in PPP loan SBA Form 2483, can subject you to potential prosecution for fraud under federal law. Violation of a federal fraud law can result in criminal liability, which can lead to significant fines and possible imprisonment, as well as other potential collateral consequences.
C. What portion of the PPP loan proceeds may be forgiven?
At the end of the eight-week Forgiveness Covered Period, if you want to have all or a portion of your PPP loan forgiven, then you will need to file a written application with your lender to request the forgiveness. Why is it important to seek forgiveness? There are two reasons. First, the portion that you are not required to repay (i.e., that is forgiven) is treated as a nontaxable grant, so there is no cost to you. Second, any portion of the PPP loan that is not forgiven must be repaid within two years of receipt (after a six-month payment deferral), with interest at 1%. Although the interest rate is low, you still must repay the principal that was borrowed; and these payments could start while you still are recovering from the economic effects of the COVID-19 pandemic.
The portion of the PPP loan that may be forgiven, which includes both the loan principal and accrued interest, is determined at the end of the Forgiveness Covered Period, based upon the amount of Payroll Costs, and eligible mortgage interest, rent and utilities that you both incur and pay during the Forgiveness Covered Period. There are several things to watch for in this regard:
- Payroll Costs for this purpose do not include compensation, for each employee, in excess of $100,000 annually ($8,333 per month), and the other expenses are tied to the February 15, 2020 date described above.
- Although interest paid on unsecured loans that were in effect on February 15, 2020 is an eligible expense that can be paid from the PPP loan proceeds, this interest is not eligible for forgiveness – only interest on a loan that is secured by a mortgage on real property that was in place on February 15, 2020 may be forgiven.
- All payments that are used in the forgiveness calculation must be both incurred and paid during the Forgiveness Covered Period. Payroll, utilities and mortgage interest generally are paid in arrears, so it may be that you cannot include a portion of the payments made in the initial weeks of the eight-week period, because these expenses were incurred prior to the Forgiveness Covered Period. Likewise, rent generally is paid in advance, so payments made in the latter part of the eight-week period will not count if they are incurred after the Forgiveness Covered Period. How to deal with these issues will require SBA guidance.
- The U.S. Treasury and SBA have also determined that forgiveness of owner compensation replacement for individuals with self-employment income who file Schedule C will be limited to an amount equal to eight-weeks of 2019 net profits.
D. What can cause a reduction in the amount of forgiveness, and is there a way to avoid such a reduction?
The amount of your PPP loan that is forgiven can be reduced for one (or both) of two events that occurred during the Forgiveness Reduction Comparison Period:
- Reduction in FTEs: Divide (1) the average number of FTEs per month during the Forgiveness Covered Period by (2) either of the following (your choice) (a) the average number of FTEs per month employed between February 15, 2019 and June 30, 2019, or (b) the average number of FTEs per month employed between January 1, 2020 and February 29, 2020 [you should choose the lower of the two averages to minimize this result]. If the quotient is less than 1, then multiply the quotient by the already calculated forgiveness amount to determine the reduction.
- Reduction in Compensation: The amount to be forgiven will be reduced by the amount of any reduction in salary or wages paid to any one or more employees during the Forgiveness Covered Period that is in excess of 25% of the total salary or wages paid to such employee or employees during the most recent full quarter that the employee was employed prior to the start of the Forgiveness Covered Period. For this purpose, any employees who received, during any single pay period in 2019, wages or salary at an annualized rate of $100,000 are excluded from the calculation (i.e., the reduction in the salary or wages of these employees is excluded for purposes of calculating this reduction).
The reductions described above can be avoided entirely if the FTEs who were furloughed during the Forgiveness Reduction Comparison Period are rehired or salary reductions made during the Forgiveness Reduction Comparison Period are restored by June 30, 2020. In other words, even though the reduction may apply at the end of the Forgiveness Covered Period (if that falls before June 30), you will have a chance to avoid the reduction, and to maximize your forgiveness, if you reverse the applicable reduction(s) by June 30, 2020.
There are a number of unanswered questions in the calculation of the forgiveness, the reductions and the exemption from the reductions that will require guidance from the SBA.
As previously stated, you will need to submit your written application for forgiveness at the end of the Forgiveness Covered Period. The CARES Act states that the lender will make a decision on your application not later than sixty days thereafter, and the SBA then must remit the amount of forgiveness to the lender no later than ninety days after the lender determines the forgiveness amount. It is not yet clear how this process will work, or whether lenders will extend forgiveness until they have received the forgiveness payment from the SBA, but our best guess is that you will not have a final decision on forgiveness for approximately 150 days after you submit your application. Fortunately, this delay still should end before the lapse of your six-month payment deferral period.
E. What documentation will be required?
This question actually has two parts – (1) what documentation will you need to prove that you spent the PPP loan proceeds on eligible expenses, and (2) what documentation will you need to justify your request for forgiveness?
Use a Separate Bank Account: You need to document and track how you are spending the PPP loan proceeds. Best practices in this regard call for you to segregate the PPP loan proceeds into a separate bank account, as this will facilitate proper tracking. Because cash is fungible, commingling the funds with your other cash could make it more difficult to prove that you spent the funds appropriately. Using a separate account will allow you to track the funds in and out of the account directly to the Payroll Costs and other eligible expenses to which you apply those funds.
Early Computation of Base Numbers: It is prudent to calculate and document the base numbers that you will need for determining your forgiveness and reduction, including the average FTE counts per month for the two allowable periods (2/15/19 – 6/30/19 and 1/1/20 – 2/29/20) and the compensation paid during the full quarter prior to the Forgiveness Covered Period. Having this data available will help you in planning, in case it is necessary to bring back FTEs or restore compensation prior to June 30, 2020.
Other Documentation May Be Required – Stay Tuned: The SBA has not yet published guidance on what actually must be submitted on the application for loan forgiveness. The CARES Act appears to require documentation on: (1) FTEs, (2) payroll and pay rates, (3) support for non-payroll costs, and (4) a certification that: (a) the documentation is true and correct, and (b) the amount for which forgiveness is requested was used for eligible purposes. There is a lot of detail that is not yet known in this regard, however, and the SBA can require any other documentation that it determines is necessary.
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Based on the above information, we highly recommend that you stay in close contact with your SBA lender as to any updates, or specific lender PPP loan forgiveness requirements, maintain accurate records and carefully track the use of your PPP loan proceeds, and be on the lookout for any loan forgiveness certification forms or applications specific to your SBA lending institution. We will provide further details as quickly as possible after the SBA provides guidance. In the meantime, if you have any questions, please contact a member of the Trenam COVID-19 Response Team with any questions.