On Friday, May 15th, the SBA issued the Loan Forgiveness Application that will be used by PPP borrowers to determine and report how much of their PPP loan will be forgiven.
Most readers know that the Payroll Protection Program loans are extended based upon 2½ months of payroll, health insurance and retirement plan expenses, and are forgiven based generally on the same expenses plus certain interest, rent and utility expenditures that are made in the first eight weeks following the date that the first loan proceeds are received, subject to dozens of rules, many of which are ambiguous or uncertain.
The Application and Instructions are not without issues, but they resolve a number of calculations and substantive questions that we have been hoping to have answered. Business owners and their advisors have been spending significant time determining how these rules can help their businesses to survive, and what gray areas or loopholes might help to make up for the borrower unfriendly aspects of the program.
The most notable items addressed in the Application and Instructions are as follows:
1. Payroll Paid After the Eighth Week. Payroll expenses do not have to be both “paid and incurred” in the exact eight week period (56 days) that begins on the day that the first loan proceeds are received.
By the language of the CARES Act, and the regulations and FAQs issued by the SBA, only payroll that was actually paid during the eight weeks for services actually rendered by employees, plus applicable PTO used during that eight weeks, were going to be forgiven.
This was going to cause a significant hardship, and accounting nightmares for the majority of businesses, which pay their workers in arrears.
The Application allows the borrower to choose to use the 56-day period following the receipt of the first loan money, which is referred to as the “Covered Period,” or to select the “Alternative Payroll Covered Period,” to coincide with the payroll schedule of the borrower, if it is bi-weekly or more frequently.
The Alternative Payroll Covered Period, if elected, will begin on the first day of the borrower’s first pay period following the date that they receive their first PPP loan dollars, and will end on the 56th day thereafter. This assumes that all borrowers pay their employees in full on the last day of each pay period.
Employers who pay their employees after the last day of the pay period may still lose the forgiveness of payroll that is paid in arrears beyond the last day of the last pay period that is within the 56 days, and should therefore adjust their procedures accordingly.
Employers who pay monthly should adjust their procedures to pay every two weeks so that they can qualify to use the Alternative Payroll Covered Period.
A borrower that elects to use the Alternative Payroll Covered Period must also account for employee health insurance, retirement plan contributions, and state and local taxes assessed on employee compensation during the same period of time, but will keep track of rent, interest and utilities for the “Covered Period” (the first 56 days after the receipt of the first PPP loan amount), subject to the rule described in Section 3 below.
No Further Relief in Sight. Treasury Secretary Mnuchen was asked by a news commentator on Friday whether there will be some sort of extension added for businesses, like restaurants, that are still shut down for the eight weeks after receiving their loan, and he indicated that there was nothing planned to help ameliorate this problem. Our favorite restaurant in Clearwater was closed for good last week, possibly in part because of this strict requirement.
2. Rent and Interest on Non-Real Estate Secured Loans and Leases. Rent and interest paid on leases of non-real estate business assets, and interest paid on loans that are secured by non-real estate “mortgages,” which are normally referred to as “Security Agreements,” will qualify for forgiveness, if they are based upon loans and leases that were in effect on February 15, 2020.
Planning Idea. It is unknown whether below market value loans or leases could be modified after February 15th to reflect fair market value interest or rent. Many borrowers will amend related party loan and lease agreements to reflect fair market value, pay fair market value during the eight weeks, and then wait for further guidance before filing the Forgiveness Application in order to determine whether the forgiveness will apply to the rate of interest or rent that was applicable under the agreement that was in effect on February 15, 2020, or whether the higher fair market value amounts paid during the eight week period can be counted.
3. Interest Rent and Utilities Paid in Arrears. Interest, rent and “utilities” that are incurred during the eight week repayment measurement period and paid shortly thereafter in the normal course of business will also qualify to be forgiven.
This provision of the Application reads as follows:
An eligible nonpayroll cost must be paid during the Covered Period or incurred during the Covered Period and paid on or before the next regular billing date, even if the billing date is after the Covered Period.
The above language will not apply to health insurance or retirement plan contributions, because they are considered to be “payroll costs” under the applicable terminology.
4. The 75% Rule Is Not An “All Or Nothing” Requirement. There has been much confusion over whether this rule being imposed by the SBA, which indicates that forgiveness will be limited if 75% of the amounts loan amount is not spent on payroll, health insurance and pension expenses.
Some individuals, and the New York Times last week, thought that this meant that if the borrower only spent, for example, 74% of the PPP loan money on payroll, health insurance and pension expenses, there would be no forgiveness whatsoever.
The rule makes it clear that the borrower can first determine its payroll, health insurance and retirement plan expenses (which we will call the “Payroll Amount”) and then the sum of the other forgivable expenses (“rent, utilities, and interest”) cannot exceed 33 1/3% of the Payroll Amount.
For example, if the loan is $100,000, and only $70,000 is spent on payroll, health insurance and retirement plan expenses, then 33 1/3rd% of $70,000 is $23,333, and the maximum amount forgiven based on interest rent and utilities will be $23,333, so that the total loan forgiveness would be $93,333.
The language in the Instructions that confirms this states that “eligible nonpayroll costs cannot exceed 25% of the total forgiveness amount.”
5. Reduction Ratios for Reduced Workforce and Compensation. The Application indicates how to apply the related calculations with respect to reduction of what is forgiven when there is a reduction in workforce or large salary reductions for non-highly compensated employees. One clarification is that the amounts otherwise forgiven for rent, interest and utilities are also reduced if there is a reduction in the number of employees under the test.
A short video on how the rules work for employers who have fewer employees than before during the eight week period, or who reduce a non-highly compensated employee’s wages by more than 25% is available on request if you e-mail email@example.com and put “video” in the re line.
6. When Does the Eight Week Period Start? The eight week forgiveness period begins when the first PPP monies are received. A business that borrowed $100,000 on May 1st, and gets another $50,000 on May 14th, will have to track the expenses for the eight weeks beginning May 1st. The Instructions do not indicate what occurs if the second or third tranche of a loan is received after the eight week period ends. Hopefully, we will receive more guidance on this.
It is noteworthy that the present SBA guidance indicates that entities taxed as partnerships that did not receive loan amounts based upon the compensation paid to partners, and also seasonal businesses that did not receive an extra loan amount based upon the later released seasonal business rules, can now apply for additional PPP loan amounts. There is no guidance on what might be forgiven if the additional loan amount received after the eight week period has expired.
7. When Are Pension Expenses “Paid and Incurred? The Instructions indicate that the total “amount paid by [the] Borrower for employer contributions to employee retirement plans” will be entered in the calculation worksheet, and we now know that this will be based upon the above-referenced “Covered Period” or the “Alternative Payroll Covered Period,” but that there is no indication as to whether the amount that is “paid by Borrower” can include contributions attributable to an entire year, or even 2019 and 2020 combined.
We hope that subsequent regulations or FAQs will confirm that normal and ongoing expenses for health insurance and retirement plans can be included for the full eight weeks in which they are incurred, as long as they are paid within the normal course of business. It is possible that funding a pension plan for all of 2019 or all of 2020 (or even both) will qualify for forgiveness based upon the present regulations, and that non-tax qualified “retirement plans”, such as those known as “Top Hat Plans” and “Rabbi Trusts” may be used for this as well. As retirement plan expert Larry Starr of Qualified Plan Consultants, Inc. in West Springfield, Massachusetts (firstname.lastname@example.org) points out, it is mathematically possible, for example, that a one person/100% owner of an S corporation that has a high contribution defined benefit plan (say, $250,000 annual contribution) could fully meet the 100% reimbursement all by itself if our understanding that all monies contributed to the plan during the eight weeks is included without any requirements to pro-rate or allocate to a particular year or period. Larry is available to answer questions about PPP program loans and retirement plans, and is the Senior Advisor to the Government Affairs Committee at the American Society of Pension Professionals and Actuaries / American Retirement Association (ASPPA/ARA).
8. Independent Contractors, Proprietors and Partners in Partnerships May Be Left Out in the Cold. The Application and Instructions confirm an apparent intent to not permit independent contractors, proprietors, or individuals who are partners in a partnership to receive the benefit of forgiveness for the costs of their own health insurance and retirement plan contributions. We had hoped that businesses that are operated as partnerships for tax purposes would be treated the same as those taxed as S corporations or C corporations, but this will apparently not be the case, as a surprise and disappointment to many. The newly issued Instructions for what is known as “PPP Schedule A” provide that the “Payroll” will include total amounts paid by the Borrower for “employee health insurance…[and] employer contributions to employee retirement plans…[and] state and local taxes assessed on employee compensation…”
The Instructions for Line 9 provides for the inclusion of “any amounts paid to owners (owner-employees, a self-employed individual, or general partners). This amount is capped at $15,385 (the eight week equivalent of $100,000 per year) for each individual,” and reference is made to the April 14, 2020 Interim Final Rule, which indicates at FAQ #4 that partnerships would include health insurance and retirement plan expenses for “employees” in determining the amount that can be borrowed, but this guidance does not indicate whether such items would be limited to monies paid for employee health insurance and retirement plans (as opposed to being paid for partners who work for a partnership) with respect to forgiveness.
This was not a surprise to Larry Starr, who has been notifying people for weeks that the decision of the SBA to NOT allow self-employeds (which appear to include both sole proprietors and partners in a general partnership) is dramatically unfair to such entities. As noted in Number 7 above, a sole shareholder in an S corporation will get to include his full benefit costs (health insurance and retirement plan contributions) for the loan and forgiveness, while the individual who elected to be treated as unincorporated is discriminated against and will not be allowed to receive these benefits within the PPP structure. There is still hope that this might be modified, but the SBA did not do so in this release of the reimbursement form.
We will obviously be studying these and other issues relating to PPP loans, as impacted by this new primarily borrower friendly development and provide a further post soon.
For a more comprehensive white paper that we are preparing on the subject, please feel free to send me an email and put “Secret Decoder Ring” in the subject line.