On-Demand: PPP Loan Forgiveness

I think we're all familiar with PPP loans by now, but now that most of the funds have been distributed, it's time to now discuss forgiveness of these federally guaranteed loans. But first, a quick review of the PPP loan program, just to bring everyone up to speed. If you remember back about eight or nine weeks ago when the first tranche of PPP money was issued, it was really used up in a matter of days, but there is still some availability in the second tranche, about $130 billion where applications are open until June 30th. For the first tranche, the SBA approved more loans in the first 10 days of the program than they actually approved in the 10 previous years, so quite a bit of activity.

But just some quick points on the PPP loans, which is all prior to the PPP Flexibility Act Changes released last week. As you know the maximum loan amount was $10 million per borrower and it was based on two-and-a-half times the average monthly payroll. There was a lot of question about what's included in average monthly payroll, it's defined as gross employee payroll capped at an annual rate of $100,000 per employee, plus state unemployment insurance and employer paid state disability insurance, plus employer benefit costs and employer retirement costs.

Initially the loans are to be used to covered eight weeks of payroll, rent on your facility, mortgage interest on your facility, and utilities. For self-employment income, for sole-proprietors, independent contractors and active general partners, it was capped at an annual rate of $100,000 per person. When we talk about utilities, it's meant to cover water, gas, electric, telephone, both cell and landlines, internet, and transportation costs. PPP loans were meant to be fully or partially forgivable, if the funds were spent according to the specified criteria laid out by the SBA. Most importantly, at least 75% of the forgiven amount must be attributable to payroll costs.

Eligible expenses must be paid in the eight week cover period, or incurred during the eight week covered period, and they had to be paid by the next regular pay cycle or billing cycle. There are some reductions to forgiveness. If a borrower has a reduced full time employee headcount, or individual salaries in the covered period by more than 25% from the earlier reference period. These cutbacks can be eliminated through the use of safe harbor provisions included in the Cares Act and that'll be discussed in a subsequent slide.

Any portion of the loan that is not forgiven reverts to a two year loan at a 1% interest rate and principle and interest is deferred for six months after the loan disbursement date. If you follow the media as the PPP loans were approved by lenders and the funds were distributed, there was much scrutiny as certain recipients of the loans, primarily public companies, received capital. With the initial application for the PPP loans, borrowers had to certify in good faith that uncertain economic conditions due to COVID-19 make the loan necessary to support ongoing operations and also certify that the loan proceeds will be used to retain workers and maintain payroll and make mortgage interest, lease, and utility payments.

After several public companies and even the Los Angeles Lakers received PPP loans, the Treasury issued additional guidance, which suggested that the borrower's assessment of need should include consideration of their current business activity, and their ability to access other sources of liquidity. If you are recipient of a PPP loan prior to April 23, and now you felt that maybe you were not entitled to this loan, you could repay the loan by May 18th, with no questions asked. Public companies and venture capital backed and private equity backed companies were strongly encouraged to repay their PPP loans.

To address this PPP loan scrutiny, the Treasury announced on May 13, that companies that receive PPP loans of less than $2 million had made the required certification of need in good faith since they were deemed to not have access to other forms of capital in the short term. Borrowers of loans of more than $2 million and are given notice by the SBA that they did not have an adequate basis for the needs certification can promptly repay the loan and not face any penalties.

I think the utilization of PPP funds is quite easy to understand, but there are two primary factors that reduce PPP loan forgiveness. One is the reduction of headcount from the base period, and number two is wage reductions of greater than 25%. Here are two very simple examples, let's assume a company has five full-time employees earning $3000 per month in 2019. As a result of this $15,000 average monthly payroll, they're entitled to a PPP loan of $37,500, or $15,000 times 2.5.

If the headcount is reduced by two full-time employees during the covered period, the forgivable amount is reduced, so it's calculated as my PPP loan amount times 3/5 for the three out of five employees, or 22,500 is my forgivable amount and the remainder is rolled over into a two-year loan at 1%. The next category is a pay reduction, a little bit more difficult to understand. If you have five full-time employees each earning $3000 a month in 2019, and we reduce salaries from 3000 to $2000 in the eight week cover period, the 75% of the base period salary, of 75% of $3000 is 2,250. My forgiveness reduction is the 250 per employee, five employees for a year, you multiply that times 8/52, or eight out of 52 weeks. So my forgiveness is reduced by $2308, so now my forgivable amount becomes 35,192.

There are certain safe harbors for headcount reduction and reduction in salary and wage levels that if you do return to February 15th levels by June 30, kick in. Borrowers are exempted from reductions in forgiveness resulting from headcount or pay reductions if reduced full-time employee levels or salary levels in the period between February 15th and April 26, 2020, and are fully restored to those levels by June 30th, so you're restoring your levels to the February 15th levels. A simple example here, once again, five full-time employees at February 15th, we reduce headcount by two full-time employees between February 15th and April 26th, if those two employees are rehired or we hire two additional full-time employees by June 30th, no reduction in forgiveness.

If we hire less than two employees, or less than 1.9 employees, then the safe harbor does not apply and you will be penalized. The salary and wage reduction safe harbor is certainly a little bit more complicated since you're looking at this on an individual employee level. For each employee, you must determine if the average annual wages were reduced by more than 25%, you want to compare the average annual wages during the covered period, versus the average annual wages between February 15th and April 26th. If those salaries are restored by June 30th, no reduction in forgiveness. If they are not restored, safe harbor does not apply.

There are few exemptions to reductions in headcount that you will not penalized for when you're calculating your forgiveness. Those exemptions are an employee that turns down a written offer to be rehired. I emphasize that you have that in writing. You also have to assume that offer of employment was at the same salary and number of hours as before. You get an exemption for employees fired for cause, an employee who voluntarily resigns, or an employee that requests a reduction in their hours worked. Also, additional safe harbors have been established under the Flexibility Act to deal with the inability to hire similarly qualified employees, or if employees cannot be brought back due to safety concerns in your place of business. At this point I want to pass it along to Joel Barth who'll talk about forgiveness for self-employed individuals and independent contractors.

Joel Barth:Thank you Alan. I just want to amplify a little further what you said earlier about how to calculate forgiveness for self-employed individuals, or independent contractors. We're going to be looking at the compensation paid to the owner, actually, this actually has to be paid. If you have a business account, you have to pay it to your personal account, or if you have a separate account from into which the PPP proceeds were deposited, you need to pay it to another account of yours. It's going to be where it's paid during the covered period. However, that's limited to the lesser of 8/52 of your Schedule C Self-Employment Income from 2019, or $100,000, whichever is lower, but not less than zero.

If you had a Schedule C that was negative in 2019, whether it was due to business losses or accelerated Section 179, Depreciation, whatever it may be, you would not be eligible to claim any forgiveness on your own self-employment income for the cover period. Another issue is that in order to claim a category of expenses during the cover period as a forgivable amount, you had to have made a deduction in your Schedule C last year for that same category of expenses.

For example, if you didn't claim rent during 2019 in your Schedule C, even if you pay rent during the covered period, you're not allowed to get deduction for it for forgiveness purposes. The last thing to note is that while in general employee benefits and medical benefits and retirement benefits are eligible for forgiveness, those amounts paid for the benefit of self-employed individuals are not separately deductible, separately forgivable, they're included within this self-employment income, $100,000 cap. So you have to make sure that if you're deducting for forgiveness purposes amounts paid for your health insurance for example, that any amounts or premiums paid for the benefit of owners are not included in that amount that you're claiming for forgiveness because those will be included within this self-employed, independent contractor income category.

Similarly for partnerships the PPP Program provided that individual general partners were not eligible to file their own applications and that the forgiveness was going to be done at the partnership level so that the calculation of forgiveness for active general partners are based on the amounts claimed when you applied for the PPP loans. So the provision, the clarification that partners earnings were eligible for forgiveness came in the middle of the process, after some borrowers had received their PPP loans and so there was a SBA ruling that clarified that it could be deducted, could be forgiven in future forgiveness applications and they offered an opportunity to anybody who had drawn their loan previously without including any compensation for partners to go back and amend and get additional money from their PPP lender.

In any case, whether you got money for your partners or not, the calculation that you need to do for forgiveness has to follow the same principles. You can't on the one hand not have gotten any loan money based on partners comp, and yet claim forgiveness based on partners comp. Similar to self-employed individuals, the partner compensation paid during the covered period is capped at your 2019 K-1 net earnings from self-employment with certain deductions specified in the rules and then multiplied by .9235, which represents the inverse of employee portion of self-employment taxes that are not eligible for forgiveness and then it's capped at $100,000 and not less than zero. A little bit complicated by partner comp does become eligible for forgiveness.

Similarly rent, utilities, mortgage interest at the partnership level, if they're business related, can be deducted and same concept on retirement and medical benefits. For the partners, they are included, but in this calculation and not separately deductible as part of overall employee benefit costs.

Now let's talk about the changes to the PPP that came about in the Flexibility Act which was signed into law June 5th, last Friday. Everything we've talked about for the most part so far has been in connection with the original PPP, now we'll talk about the changes. Most importantly for a change is that the covered period, which was previously eight weeks has now become 24 weeks, starting with the day that the lender made the money available, but not later than December 31st. Since new loans can't stop at June 30th, the December 31st cutoff is not of substance for very many if any borrowers.

Basically the idea is that instead of spending that two-and-a-half months’ worth of payroll over eight weeks, you now have three times the number of weeks to do it. There are some areas that are unclear in the law, and for which subsequent guidance has not been issued as to whether for example lengthening the covered period to 24 weeks also means that the cap on individual employee or partner or self-employment compensation is now 24/52 of 100,000 rather than 8/52, that is unclear and awaits further guidance. Next big change is that instead of having a 75% payroll, 25% non-payroll split as the SBA promulgated in the guidance, it was changed by Congressional Act to at least 60% payroll, no more than 40% non-payroll. There was also some concern when the law was adopted about a so-called cliff, meaning that if less than 60% were to be spent on payroll, that somehow nothing would be forgiven.

It was clarified in a press release by the treasury and then some additional clarifying guidance last night that there is no cliff, that you'll always have partial forgiveness, but the total amount forgivable is driven by that 60% payroll number. Sorry, the next change is that the safe harbor date that Alan was talking about for restoration of headcount cuts or salary cuts, which was June 30th, is now pushed back to December 31st, 2020. So a lot more time to bring people back, or to restore wage cuts to eliminate potential cutbacks to the forgiveness amount, very important.

Similarly, there were two new safe harbors added as Alan mentioned. One, for the inability to rehire individuals employed on February 15th, or inability to hire similarly qualified individuals by December 31st, so that's the first one. The second one is a new safe harbor for a documented inability to return to your February 15th, 2020 level of business activity before December 31st, 2020 due to compliance with various requirements established by federal agencies, not necessarily state or local. This is a big one. It's an important one. Unfortunately there's not a lot of guidance on what that means, inability to return, how it's measured, how it's documented.

While many borrowers should be able to benefit from this safe harbor if their business hasn't fully returned to normal by the end of the year, it awaits further guidance and application for instructions to see exactly you make that burden of proof. There was an exception in the new rules, the new Flexibility Act that said that if borrowers had received their loans before the Flexibility Act was enacted on June 5th, and had already been planning to and had spent their funds for maximum forgiveness in the eight weeks, they can choose to end the covered period eight weeks from their original loan date and file the application now.

We strongly recommend that only borrowers who know they have full forgiveness in the eight week period avail themselves of those options. Everybody else, I think, gets several more months to see how the rules evolve, see how business conditions evolve, and spend that money before they submit forgiveness. Another item that's unclear based on what's been published so far, is whether or not a borrower can end their period somewhere between eight weeks and 24 weeks if you couldn't spend all the money in eight, but if you could spend all the money in 12, can you cut off your period and file as of the 12th week and the answer to that unfortunately, still remains unclear.

Another provision of the Flexibility Act was that the maturity of loans issued starting last Friday and beyond is extended to five years automatically with interest remaining at 1% per annum. With existing loans that were outstanding on that date, borrowers and lenders have the ability to mutually renegotiate existing loans. Everybody who believes they're not going to have full forgiveness ought to be reaching out to their lenders to see if they can agree to extend the loan to five years, but unfortunately it has to be a mutual decision.

Another important item in the Flexibility Act was that principle and interest payments, instead of being due after six months, are now deferred until the day the forgiven amount is remitted to the lender, which is approximately five months after the forgiveness application is submitted unless there's a denial on appeal, which pushes it out even further, or if you don't file a forgiveness application 10 months after the end of the covered period. We'll talk a little bit more about the forgiveness process in a later slide, all right? The last thing is that under the Cares Act originally is adopted, they were provisions to allow employers to defer in the employer portion of payroll taxes until part into 2021 and part in 2022 but the rules provided that once you had any loan forgiveness, your ability to continue deferring payroll taxes stopped. Under the Flexibility Act that provision was removed. Employers can both defer employer payroll taxes and get full or partial forgiveness.

Let's talk for a minute about the actual loan forgiveness process. You need to submit an application for loan forgiveness to the lender that originated your loan and complete it and submit it. The forms themselves were made available in mid-May on the SBA and treasury websites. However, in light of the Flexibility Act, those forms need to be revised, and they have not yet. At this point, anybody planning to take advantage of the benefits of the Flexibility Act doesn't even have a form to start working on, not even clear whether anybody who is eligible for the eight week cutoff period, whether the banks will accept your forgiveness application on the old form yet, but it's likely that in the very near future, there'll be new forms, new instructions, new guidance to come, but we haven't seen them as of yet.

Once that form is submitted to the lender and the guidance specify certain aspects of the forms that the lenders must review and certify to the SBA, there are other parts of the forgiveness application that are the borrowers' responsibility. In the end, the whole thing is the borrowers' responsibility and various certifications under penalty of perjury have to be made when you submit your application form, but only certain documents and certain data needs to be provided to your lender and then the lender has to perform a verification and recalculation procedures on it.

It's 60 days for the lender to get it to the SBA. The SBA then has up to 90 days beyond that to review the application, either the forgiveness calculation or even the question of whether you are eligible to receive the money. They can step in at any point during the next 90 days. If they choose to step in, there's a whole process that follows that including possibly rights of appeal by the borrower and more guidance that hasn't come out. But assuming they don't choose to step in and review during that period, at the end of the 90 days they will submit to the lender the amount of the loan and accrued interest, which is being forgiven at that point, the lender can make final notification to the borrowers of the amount. However, the rules require that the borrowers and the lenders keep the information and all the supporting documents on file for up to six years from the forgiveness date and the SBA retains the right to come in at any time during that period and review or audit loans.

The treasury has made it clear that they're going to be performing some level of review process on all individual loans above $2 million. There's actually a box to be checked on the application form indicating whether the borrower and its affiliates receive more than 2 million, that presumably treasury will use, and the SBA will use in deciding how to audit. All right, just some other miscellaneous considerations related to forgiveness. Forgiveness under recent IRS notice, the forgiveness of the loan will not be included in taxable income, however, the deductions for the ordinary business expenses that were paid with that forgiven money will not be allowed. Effectively, it's a back doorway of making the loan forgiveness amount taxable for a company that otherwise is a tax payer.

There was some political pressure about trying to change that, but so far no changes, so that's the current status of forgiveness from a tax perspective. Supporting documents must be retained. We talked about that. Prepayments of interest, the rules are clear, are not an allowed use of PPP funds and not eligible for forgiveness. However, the guidance when they had the opportunity to say prepayments of rent, or prepayments of utilities or anything else, are not eligible for forgiveness. The rules did not say that. I would say the language at this point is unclear about prepayments during the cover period.

The last thing we'll mention is that the rules are clear that if you, as an employer, for your employees, not for yourself, give out additional hazard pay, bonuses, or commissions during the cover period, those are eligible for forgiveness. So primarily it's about payment, much less about when the expense was incurred for this purpose. They're really opening up the possibility of these extra payments if even the 24 weeks is not enough to get the full forgiveness, you have an opportunity to pay some bonuses here that can be thrown into the forgivable amount.

Allen Wilen:There are only a handful of questions, like as in 150 or so questions, so I'm going to try and get to some of the key points for folks that were raised. I'm going to aggregate the questions, because many of them are similar in nature. Is there an advantage to get your forgiveness application in early?

Joel Barth: I'll take that one. My view is the answer, once the Flexibility Act is enforced, is no. The only advantage would be if you're confident of full forgiveness and you want to get that notification, take the payment off your books, take the liability of your books and know that it's done, I guess you can submit in this timeframe. I think the overwhelming majority of borrowers, one way or another will benefit from the extended periods offered by the Flexibility Act and now with the payment deferral, even if you aren't getting full forgiveness, if you wait until later on to submit your application, that pushes out the start date of your repayments even further because the initial payment date is tied to either the forgiveness amount being approved by the SBA, or 10 months after the end of your covered period.

Allen Wilen:Okay, another one that popped up a couple times, can two companies that are classified as affiliates for SBA select separate elections of June 30th and December 31st deadlines?

Joel Barth: I would say it's not clear particularly in the guidance that's been put out. The concept of affiliates was very significant back when borrowers were trying to figure out if they qualified for a loan to begin with, whether they had more than 500 employees with their affiliates or met various other alternative side tests that the SBA established. A lot of talk about affiliates in the loan origination process, very little talk about affiliates in the forgiveness process.  For different borrowers, even if they are affiliates, I don't see any rule that says they both have to use eight or they both have to use 24. Alan?

Alan Wink:Allen, just to add to that, probably the reason that the covered period was extended to 24 weeks was because so many of the borrowers who receive PPP loans felt they could not spend the money in the eight week cover period. Their businesses were not yet open for business and they didn't feel the need to keep paying their employees, since there was no place for them to go to work. I assume if you have affiliates, one business that, for example, was open during the eight week cover period and could continue operations, and a second that was not going to be open for several weeks, I assume they each could apply to their own period that would be beneficial to them.

Allen Wilen:Okay. How does a reduction in pay to those over $100,000 per year affect forgiveness. For example, I have an employee who makes $150,000 a year and I dropped him to $125,000 a year, but they're in the calculation only at a $100,000 a year for the original loan application. Does that impact forgiveness?

Joel Barth:We didn't go through every bit of the minutiae of all these rules, but one of the rules that we didn't cover that's directly relevant to this question is that if you have an employee who earned during any pay period in 2019 earned at an annualized rate of over $100,000, then that person, regardless of what they actually made in 2019, regardless of what they actually made in the first quarter of 2020, or the cover period, that person is totally out of the salary reduction to forgiveness that Alan was describing earlier, the 25% grace period. If you had an employee that was cut from a million a year to 10,000 a year, that would have no effect on the forgiveness calculation. But if an employee was cut from 90,000 a year to 50,000 a year would.

Allen Wilen:Great. Now, another question that came up which is quite frankly an interesting one, which is, can I rehire all of my employees on June 29th then fire them all on 7/31?

Alan Wink:Allen, that's a really interesting question, because they're not looking in terms of the forgiveness amount on the eight week covered period, they're not looking beyond the 56th day. I'm going to assume that a lot of companies that were recipients of PPP loans made it through the last eight weeks because of this money and if they're not back to normal operations after the eight week covered period, will probably looking at other alternatives to save operating costs and laying off people might be one of the things they'd be looking to do.

Joel Barth:I was just going to add to that, for purposes of that June 30th safe harbor where ... If you cut between February and April and restored the cuts by June 30th, or now December 31st, I would say while technically the rule doesn't ... just talks about what your annualized salary is, or what your scheduled FTE status is on June 30th or on December 31st, I would think it would not be in good faith for you to hire somebody on June 29th, and let them go on July 2nd solely for purposes of the safe harbor. I think there's probably implied good faith obligation that if you wait till June 30th to hire somebody back, that you have every intention of keeping them on that level going forward. Now if circumstances drastically change and you have to reevaluate that decision based on subsequent health conditions, or economic conditions or anything else, then you have a good story to tell. But I would not bring somebody back for a day, claim the safe harbor and let them go on Monday.

Alan Wink:And Allen, just to add one other thing to that. You look at, Joel mentioned it before, the distinction between the eight week cover period and the 24 week cover period, is it eight or 24, or something in the middle? For example, if you elected the 24 week cover period and at the end of 12 weeks you've used up all your PPP loans, are you obligated to keep your people on payroll for the subsequent 12 weeks after that? That's really something that has to be answered in future guidance.

Allen Wilen:How does bonus compensation fall into place here? Can I give bonuses to my employees as a way of using up PPP money?

Joel Barth:Yes, as long as you pay them during the covered period, as long as you don't go over $100,000 annualized per person.

Allen Wilen:Another question that continues to come up is, how does headcount reduction and payroll reduction interrelate? If I have both a headcount reduction and a payroll reduction process, which one do I take and use?

Alan Wink:Well Allen, you look at each one separately. You could get penalized both for a headcount reduction and for a wage reduction, but you're not going to get penalized for the same person for a reduction in wages and a reduction in headcount. For example, if an employee what was let go, that will be a headcount reduction, you would not get penalized for his wage reduction also.

Allen Wilen:Okay. What happens if I can't operate at 100% level and get back to normal? I own a restaurant, or a retail location that we just can't get there, and we don't know when we're going to reopen enough to get back to full employment. Is there provision there to protect those folks?

Joel Barth:Well that's the new safe harbor that was added in the Flexibility Act that isn't particularly well defined at the moment. If your inability to get back to operating conditions that existed as of February 15th, by December 31st, then this new safe harbor was created but it's not especially clear exactly how that has to be documented, whether there's a quantitative test looking at revenue, or looking at profitability or looking at headcount, it's just not clear at this point, so I think we'll need to stay tuned for future guidance and a future webinar to talk about that.

Allen Wilen:Okay. If someone got a PPP loan where they excluded all their K-1 partners in the original calculation, can they use them in the forgiveness calculation? Or do you have to match person for person?

Joel Barth:I would think that you have to go using the same methodology, so that if you didn't get them and you didn't take advantage, or there was a window where you could have gone back for a second loan, but I believe that window is closed. If you didn't borrow any money based on partners, I don't think it's a good idea to try to claim forgiveness based on partners. But on the other hand, on employees, you got 10 weeks payroll in the loan, and you can have up to 24 weeks payroll in the forgiveness covered period. Hopefully that extended amount of the time on the employees will let you get closer to full forgiveness.

Alan Wink:And also Allen, with the headcount piece, it's not employee to employee. For example, if you had 100 employees and you didn't bring back five, but you hired five new ones, you're at the same employee level, that's fine.

Allen Wilen:Is the FTE calculation to be done on the given day, or is it a rolling average if somebody has headcount that varies?

Joel Barth:The rule is that for whatever period you're measuring FTEs for, whether it's the covered period, or it's the reference period, we did really get into great detail about that, but when you calculate your fraction based on headcount reduction, there are choices of different prior reference periods you can use as the basis and depending on whether you're seasonal or not, its various points during 2019 or even January/February 2020. Whatever your period you're calculating FTEs for, it needs to be done on a pay period by pay period basis. You'd look and you'd see in a particular pay period using a 40-hour week as a standard, what percentage of a 40-hour week did each employee work, but not more than one, so don't count overtime if it gets you over 40, don't count a salaried worker who puts in regularly 50-hour weeks. It's maximum one, and then what percentage of the 40-hour week did you work in each pay period, and then average up the pay periods for whatever period you're trying to calculate.

One thing we should also note is that the most recent rules provided by guidance in mid-May by the SBA says that if you don't want to go through the trouble of calculating FTE equivalents for part time employees, you can elect to count every part time employee for every relevant period as .5. For some companies that could be better, and for other companies it could be worse, but it would certainly be easier if that's what you choose.

Allen Wilen:Great. We're up against the two 45 timeframe that we had booked. I want to ask one more question that continues to come in and I want to make sure that we answer it again. I think it was actually discussed already, but I want to make sure. It keeps coming back for questions is, the comment that keeps continually made is, has the cap now been increased to 46,154 from the $8,000 number it was before per employee, if you go to 24 weeks?

Joel Barth:Remains absolutely unclear as of this moment in time. Unless the SBA puts something out since we've been on the phone, which I wouldn't put it past them. But as of right now, as of this morning, there was no guidance either way as to whether the 8/52 cap becomes a 24/52 cap.

Alan Wink:Allen, certainly there's a continued amount of ambiguity on the 24 week period.

Allen Wilen:Okay, great. That's actually a very popular question on the list of questions, which I thank everybody, we're up to about 250 questions or so at this point, everyone's very interactive here and that's wonderful. I thank everyone for joining us today. I expect that we will be doing a follow-up to this webinar in the near future as we have additional guidance from the SBA on forgiveness. I do want to thank everyone for joining us today.