Guide for maximizing PPP loan forgiveness

As noted in our firm’s previous email alerts, President Trump signed into law on March 27, 2020 the Coronavirus Aid, Relief, and Economic Security Act, commonly referred to as the CARES Act. Among other provisions, the CARES Act created a Paycheck Protection Program (“PPP”) which provides for loans to small businesses that can be entirely forgiven, if used in certain ways (primarily for payroll costs). The CARES Act originally provided for $349 billion in funds for such loans, which were eligible for disbursement through June 30, 2020. While the initial funds have been exhausted, it is being reported that additional funds in the amount of $310 billion may be allocated by Congress soon. As such, small businesses interested in PPP loans that have not yet been approved should consider reaching out to their lenders immediately.

Clearly, for those businesses that have applied, and especially those that have received funds, determining how to achieve forgiveness of the loans is of great import. As the CARES Act was passed on an expedited basis, there are still a number of questions that the language of the statute and subsequent guidance still leave unanswered. The SBA, which is responsible for administering PPP loans, has stated that additional guidance is forthcoming (and has noted that it may revise current guidance). Nevertheless, in the meantime, businesses should be cognizant of what information is currently available and act accordingly to maximize the amount of their PPP loan funds that can be forgiven.

Below is a guide for maximizing PPP loan forgiveness, with tips and information that our firm has compiled with information currently available. Again, this information may be subject to change as additional guidance is made available.

Step 1: Upon Receipt of PPP Loan Proceeds, Create and Deposit Such Proceeds in a Separate Bank Account.

Upon receipt of the PPP loan proceeds, borrowers might consider (i) putting them in an isolated account to ensure that they are not comingled with other operating funds, and (ii) only disbursing funds from the account for “covered expenses” during the “covered period” (each of these terms is discussed further in Step 2 below).

Step 2: Use Proceeds for Covered Expenses during the Covered Period (and Retain Supporting Documentation).

What are “Covered Expenses” for PPP loan proceeds and what is the “Covered Period” during which the PPP funds must be used?
  • Pursuant to U.S. Treasury and Interim SBA rules, you must use at least 75% of PPP loan proceeds to pay for payroll costs (which is a term of art that is still causing some confusion due to conflicting publications from the SBA) incurred in the 8-week period following the disbursement of the loan. This 8-week period is called the “covered period” in the forgiveness portion of the CARES Act.
  • No more than 25% of loan proceeds may be used for certain other qualified expenses, including: to pay rent (for leases in force prior to February 15, 2020), mortgage interest (for mortgages originated prior to February 15, 2020), and utility payments (i.e. electricity, gas, water, transportation, telephone and/or internet for which service began prior to February 15, 2020) during the 8-week “covered period” following disbursement of the loan. For sake of clarity, payrolls costs and the other above expenses are referred to as “covered expenses” in this guide because they are expenses that PPP funds can be used to pay.
  • For forgiveness, PPP funds must be used to pay for covered expenses that are incurred and paid during the covered period (i.e. 8-weeks following the disbursement of the PPP loan funds).
  • Please note that the PPP loan application had boxes to check for the types of covered expenses that the loan proceeds are intended to be used to pay. Borrowers should spend the funds consistently with the boxes that were checked in their applications.
  • The language of the CARES Act itself provides that borrowers are eligible for forgiveness of indebtedness in an amount equal to the sum of the “costs incurred and payments made during the covered period” for covered expenses. It is unclear whether the SBA is taking the position that expenses have to be incurred and the payments have to be made during the covered period. At a minimum, borrowers should not plan to prepay their rent or utilities for future billing periods that will first become due outside the covered period.

Since “payroll costs” must be the largest covered expense, what do they include?

The definition of payroll costs has been a source of particular confusion (especially the issue of payroll taxes).

  • According to the language of the CARES Act itself, payroll costs do include:
    • Salary, wages, commissions, or similar compensation;
    • Payment of cash tips or equivalents;
    • Payment for vacation, parental, family, medical, or sick leave;
    • Allowance for dismissal or separation;
    • Payments required for the provisions of group health care benefits, including insurance premiums;
    • Payment of any retirement benefit; and
    • State and local taxes assessed on compensation of employees.
  • Also, according to the language of the CARES Act, payroll costs do not include:
    • The compensation of an individual employee in excess of an annual salary[i] of $100,000, on a pro-rated basis;
    • Taxes imposed or withheld during the covered period (i.e. as defined by the statute, between February 15, 2020 and June 30, 2020), pursuant to Chapters 21, 22, or 24 of the Internal Revenue Code (e.g. federal payroll taxes);*
    • Any compensation of an employee whose principal place of residence is outside the United States; and
    • Qualified sick leave wages and family leave wages for which a credit is allowed under the Families First Coronavirus Response Act. (For more information about the FFCRA, please see the IRS guidance online).

[i] According to a non-binding Q&A published by the SBA on April 17, 2020:

“Question: The CARES Act excludes from the definition of payroll costs any employee compensation in excess of an annual salary of $100,000. Does that exclusion apply to all employee benefits of monetary value?

Answer: No. The exclusion of compensation in excess of $100,000 annually applies only to cash compensation, not to non-cash benefits, including: • employer contributions to defined-benefit or defined-contribution retirement plans; • payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums; and • payment of state and local taxes assessed on compensation of employees.”

*Some lack of clarity on the definition of “payroll costs” remains. While previous guidance from the SBA seems to follow the language of the statute, which could be read to indicate that all payroll and federal withholding taxes should be removed from the definition of “payroll costs” and therefore not be a forgivable covered expense, more recent guidance from the SBA (dated April 17, 2020) suggests otherwise:

“Under the 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 . . . .

The definition of “payroll costs” in the CARES Act, 15 U.S.C. 636(a)(36)(A)(viii), excludes “taxes imposed or withheld under chapters 21, 22, or 24 of the Internal Revenue Code of 1986 during the covered period,” defined as February 15, 2020, to June 30, 2020. As described above, the SBA interprets this statutory exclusion to mean that payroll costs are calculated on a gross basis, without subtracting federal taxes that are imposed on the employee or withheld from employee wages. Unlike employer-side payroll taxes, such employee-side taxes are ordinarily expressed as a reduction in employee take-home pay; their exclusion from the definition of payroll costs means payroll costs should not be reduced based on taxes imposed on the employee or withheld from employee wages. This interpretation is consistent with the text of the statute and advances the legislative purpose of ensuring workers remain paid and employed. Further, because the reference period for determining a borrower’s maximum loan amount will largely or entirely precede the period from February 15, 2020, to June 30, 2020, and the period during which borrowers will be subject to the restrictions on allowable uses of the loans may extend beyond that period, for purposes of the determination of allowable uses of loans and the amount of loan forgiveness, this statutory exclusion will apply with respect to such taxes imposed or withheld at any time, not only during such period.”

What documentation will borrowers be required to keep to ensure forgiveness?

Current guidance has not definitively answered this question yet. However, documentation supporting loan forgiveness to be submitted to the PPP lender may consist of the following, to the extent they are applicable for covered expenses that were paid by the borrower:

  • Payroll tax filings reported to the IRS and state income, payroll, and unemployment insurance filings.
  • Utility company bills and receipts.
  • Rent statements and receipts.
  • Mortgage or monthly statements (NOTE: Because mortgage interest is one of the covered expenses, but repayment of principal is not, borrowers might consider writing separate checks to differentiate these amounts).

SBA said in its Interim Final Rule, published on April 15, 2020, that it will issue additional guidance on loan forgiveness, but, at a minimum, borrowers should be prepared to document their expenses with the documentation noted above. This documentation should be retained certainly until the applicable lender has approved the application for forgiveness and beyond that to ensure that it is available during any subsequent potential SBA audits.

Step 3: Calculate Eligible Forgiveness Amount and Reductions.

  • Once the PPP loan proceeds have been properly spent on covered expenses during the covered period, there are still two ways that the otherwise eligible forgivable amount can be reduced.
  • Headcount Reduction.
  • The amount otherwise subject to forgiveness will be reduced by multiplying such amount by:
    • the average number of full-time equivalent employees per month during the covered period (i.e. the 8-weeks after the loan is disbursed), divided by
    • the average number of full-time equivalent employees per month during one of the following periods (as selected by the borrower):
      • February 15, 2019 through June 30, 2019, or
      • January 1, 2020 through February 29, 2020
      • (NOTE: Borrowers should immediately do a headcount of the time periods above and see which of them is most advantageous to select).
    • Compensation Reduction.
      • The amount of loan forgiveness otherwise available will also be reduced by the amount of any reduction in total salary or wages of any employee during the covered period that is in excess of 25% 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 (i.e. the 8 weeks after loan disbursement).
      • Importantly, however, borrowers will only be penalized for reductions in the salary of employees 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.
      • Guidance is still needed from the SBA to address several issues borrowers will face when calculating the 25% compensation reduction. For example, how should bonuses, commissions, or other forms of compensation be considered in this calculation for comparing compensation? In addition, if an employee is terminated and replaced, will that automatically reduce the forgivable loan amount or will the original employee’s salary be compared to the replacement worker?
    • Rehiring Restoration of Forgivable Loan Amount.
      • The CARES Act states that for employees that were terminated or whose salaries were reduced during the period from February 15, 2020 through April 26, 2020 (i.e. 30 days after the enactment of the CARES Act), borrowers will not have their loan forgiveness reduced if the decrease in full-time equivalent employee headcount and wages is eliminated by June 30, 2020. However, further guidance is needed from the SBA on whether part or all of the headcount and wages need to be restored.

Step 4: Submit Necessary Documents to Lender.

After the 8-week covered period following the loan disbursement date, borrowers will need to submit loan forgiveness documentation to their lender. The lender must make a decision on the forgiveness within 60 days upon receipt of such loan forgiveness documentation. As discussed above, more guidance is needed by the SBA on what this documentation entails, but it will likely include at least the documents referenced above in Step 2,as well as:

  • A formal application yet to be released by the SBA;
  • Certification from a company representative that the documentation presented is true and correct and the amount for which forgiveness is requested was used to retain employees, and, if applicable, make payments on other covered expenses (e.g. mortgage interest, rent, or utilities); and
  • Any other documentation the SBA determines necessary.

Step 5: Make Payments for Amount of PPP Loan Not Forgiven.

If a portion of the loan is not forgiven, such amount is due and payable within 2 years, accruing interest at 1% per annum. Interest and principal payments are deferred for a 6-month period from the date of the loan, though interest will accrue during that 6-month deferment period. The CARES Act provides that the amount forgiven will be tax-free for federal purposes.

Notably, the language of the CARES Act indicates that interest accrued on the PPP loan during the forgiveness period cannot be forgiven, but subsequent SBA guidance states that it can (i.e. that the borrower may not have to repay any money whatsoever). Again, further guidance from the SBA may be forthcoming on this matter.

For help with the CARES Act, please email Bill Underwood or Brandon Hurwitz.

Our professionals are available via email, phone, online meetings and video conferencing to continue to serve you. If you would like to meet for an important matter for you or your business, we can plan accordingly.

Underwood Perkins, P.C. (972) 661-5114