- Forgiveness amounts on owner/employee compensation are capped across all businesses; additional limitations based on the type of entity of the borrower are also included
- Payroll and non-payroll calculations are clarified
- “Transportation” costs as a “Covered Utility Payment” has a very limited definition, and does not include transportation expenses such as fuel costs as forgivable expenses
- Calculation of reduction in forgiveness amount from reductions in FTEs and salaries/wages and applicable safe harbors explained
- Borrower is responsible for payment of principal and interest on portion of loan that is not forgiven, but not for any portion of the loan that is forgiven
- Borrowers may receive both a PPP loan and an EIDL grant, but the amount of forgivable PPP funds is reduced by the amount of the EIDL grant
On August 4, 2020, the Small Business Administration (the “SBA”) issued additional guidance on forgiveness of Paycheck Protection Program (the “PPP”) funds in the form of “Frequently Asked Questions” (“FAQs”), which can be found here. Most of the FAQs reiterate information already published by the SBA in the PPP forgiveness application and in Interim Final Rules but in other cases, provide new insight for both borrowers and lenders. See our prior client alert on the PPP forgiveness application here and the Interim Final Rules here and here. The FAQs were subsequently amended on August 11, 2020 to clarify how forgiveness is impacted for borrowers that received funding under both the PPP and the Economic Injury Disaster Loan program (the “EIDL”).
Congress created the PPP under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) through the SBA to provide forgivable loans to eligible small businesses facing economic hardship to retain U.S. employees on their payroll during the COVID-19 pandemic. Our prior alerts on the PPP can be found on our COVID-19 crisis response group website here.
Although most borrowers are still within the “Covered Period” during which the PPP funds may be used (generally 24 weeks after disbursement, or alternatively, 8 weeks after disbursement, for borrowers that received funds prior to June 5, 2020 and elected to use the alternative period of 8 weeks), many have already expended their funds and can now apply for forgiveness.
We have summarized in this alert some of the more significant items included or clarified in the updated FAQs to help borrowers apply for forgiveness.
Payroll Cost Forgiveness Considerations
Forgiveness for business owner compensation is capped
As discussed in our June 22nd client alert referenced above, the Paycheck Protection Program Flexibility Act of 2020 provided a safe harbor for borrowers, exempting them from loan forgiveness reductions, if they are unable to return to the same level of business activity as they were operating at before February 15, 2020. Additionally, the SBA capped the amount of forgivable funds paid to an owner/employee of a business at $20,833 across all of their businesses (or $15,385 if the business received a PPP loan before June 5, 2020 and elected to use an 8-week Covered Period).
The purpose of the owner compensation replacement cap was to encourage retention of employees and their paychecks, and prevent potential PPP windfalls to owners by taking a loan based on total payroll costs (including all employees during the year preceding the loan), then laying off employees, paying themselves the entirety of the loan, and availing themselves of the safe harbor.
However, the owner compensation replacement cap can also disadvantage small businesses as owner/employees who retain their employees are limited in the amounts that they pay themselves compared to those paid to their non-owner employees (capped at $46,154). The FAQs also provide additional restrictions on owner/employees based on the type of business that they own (i.e., C-corporation, S-corporations, self-employed filers, general partners or LLC owners), in each case when describing cash compensation, subject to the overall $20,833 (or $15,385) cap described above.
- C-corporation. Owner/employees are eligible for loan forgiveness up to 2.5/12 of their 2019 employee cash compensation, with cash compensation defined as it is for all other employees. Additionally, forgiveness amounts include payments by the borrower for employer state and local taxes and assessed on their compensation, employer contributions for employee health insurance, and employer retirement contributions under employee retirement plans (capped at 2.5/12 of the 2019 employer retirement contribution). Non-cash compensation does not count toward the $20,833 cap per individual. See the FAQ’s “Loan Forgiveness Payroll Costs,” Question 8, for details on how to calculate non-cash compensation.1
- S-corporation. Owner/employees are eligible for loan forgiveness up to 2.5/12 of their 2019 employee cash compensation, with cash compensation defined as it is for all other employees. Additionally, forgiveness amounts include payments by the borrower for employer state and local taxes and assessed on their compensation and employer retirement contributions under employee retirement plans (capped at 2.5/12 of the 2019 employer retirement contribution). Unlike C-corporations, employer contributions for health insurance are not eligible for forgiveness for S-corporation employees with at least a 2% stake in the business, including employees who are family members of a 2% or greater owner, because those contributions are included in cash compensation. Non-cash compensation does not count toward the $20,833 cap per individual. See the FAQ’s “Loan Forgiveness Payroll Costs,” Question 8, for details on how to calculate non-cash compensation.2
- Self-employed Schedule C (or Schedule F) filers. Forgiveness for these filers (which include sole proprietors, self-employed individuals, and independent contractors) is limited to 2.5/12 of 2019 net profit. See the FAQ’s “Loan Forgiveness Payroll Costs,” Question 8, for details on how to calculate net profits. Separate payments for health insurance, retirement, or state or local taxes are not eligible for additional loan forgiveness (health insurance and retirement expenses are paid out of their net self-employment income). 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 loan, it must be included with the borrower’s forgiveness application.
- General Partners. General partners are eligible for loan forgiveness up to 2.5/12 of their 2019 net earnings from self-employment that is subject to self-employment tax. See the FAQ’s “Loan Forgiveness Payroll Costs,” Question 8, for details on how to calculate net earnings from self-employment. Compensation is only eligible for loan forgiveness if the payments to partners are made during the Covered Period or Alternative Payroll Covered Period. Separate payments for health insurance, retirement, or state or local taxes are not eligible for additional loan forgiveness. If the partnership did not submit its 2019 IRS Form 1065 K-1s when initially applying for the loan, it must be included with the partnership’s forgiveness application.
- LLC owners. LLC owners must follow the instructions that apply to how their business was organized for tax filing purposes for tax year 2019, or if a new business, the expected tax filing status for 2020.
Payroll costs (1) incurred during the Covered Period or the Alternative Payroll Covered Period but paid afterwards and (2) incurred before the Covered Period but paid during the Covered Period, are all eligible for loan forgiveness
In addition to the timing for forgiveness, the FAQs provide several examples to demonstrate when payroll costs should and should not be forgiven based on when the cost was incurred and paid. In general, payroll costs incurred during the Covered Period but paid after the Covered Period are eligible for forgiveness if they are paid before the next regular payroll date. Likewise, payroll costs incurred before the Covered Period but paid during the Covered Period are also eligible for forgiveness.
Borrowers using biweekly or more frequent payroll cycle may calculate payroll starting on the first day of payroll following PPP loan disbursement date
If the borrower uses a biweekly or more frequent payroll cycle, it may elect to calculate eligible payroll costs using the 8-week (for borrowers that received their loans before June 5, 2020 and elect this Covered Period length) or 24-week period that begins on the first day of the first payroll cycle following the PPP loan disbursement date (referred to as the Alternative Payroll Covered Period), to enable calculation of payroll costs for complete pay periods. However, if a borrower pays twice a month or less frequently, it will need to calculate payroll costs for partial pay periods.
When calculating payroll for forgiveness, the FAQs clarify the following:
- cash compensation should be based on gross amounts before deducting for taxes, employee benefit payments and similar payments;
- payroll costs include all forms of cash compensation including tips, commissions, bonuses and hazard pay up to $100,000 on an annualized basis;
- premiums for employee group health care benefits for coverage during the applicable Covered Period paid by the borrower during the applicable period or by the next premium due date thereafter are eligible for forgiveness but employee-paid costs or any portion paid for coverage outside of the applicable period are not; and
- employer contributions for employee retirement benefits generally qualify as payroll costs but not (i) amounts deducted from employees’ pay or otherwise paid by employees or (ii) retirement benefits accelerated from periods outside the applicable period.
Non-Payroll Forgiveness Considerations
Interest on unsecured credit not eligible for loan forgiveness
Under prior SBA guidance, described in our June 22 alert, borrowers may qualify for 100% forgiveness provided that permitted non-payroll costs (rent, mortgage interest, and utility payments) do not exceed 40% of the PPP amounts spent. While interest on business mortgages on real and personal property (such as auto loans) are eligible for loan forgiveness, interest on unsecured credit is not because the loan is not secured by real or personal property.
Non-payroll costs incurred (1) before the Covered Period but paid during the Covered Period and (2) during the Covered Period but paid afterwards, are each eligible for loan forgiveness
Similar to payroll costs, non-payroll costs incurred during the Covered Period but paid after the Covered Period are eligible for forgiveness if they are paid before the next billing cycle. Non-payroll costs incurred before the Covered Period but paid during the Covered Period are also eligible for forgiveness.
Non-payroll costs must be paid/incurred during the Covered Period, not the Alternative Payroll Covered Period
While the “Covered Period” refers to the 24- or 8-week period following disbursement of PPP funds as described above, borrowers with biweekly or shorter payroll cycles can elect to use an Alternative Payroll Covered Period, in which the 24- or 8-week period kicks off on the first day of their first pay period following PPP disbursement. For these borrowers, only payroll costs can be incurred or paid during the Alternative Payroll Covered Period while non-payroll costs must be paid or incurred during the normal Covered Period.
Payments made on recently renewed leases or interest payments on refinanced mortgage loans eligible for loan forgiveness if the original lease or mortgage existed prior to February 15, 2020
If a lease or mortgage that existed prior to February 15, 2020 is renewed, or a mortgage that existed prior to February 15, 2020 is refinanced, on or after February 15, 2020, the payments made pursuant to the renewed lease or refinanced mortgage during the Covered Period are eligible for loan forgiveness.
“Transportation Costs” means transportation utility fees, not employee transportation costs like fuel
Under the CARES Act, forgivable uses of PPP funds include payroll costs, interest on any covered mortgage obligation, covered rent obligations and covered utility payments. Covered utility payments were defined as “payment for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.” Distribution of “transportation” was not clear for many borrowers, many of whom reasonably assumed that this included fuel costs, among other business transportation needs.
However, the FAQs state that transportation costs are limited to “transportation utility fees” assessed by state and local governments. As these pseudo-tax systems are not used in all jurisdictions, many borrowers may be unfamiliar with the term. Transportation utility fees are a financing mechanism paid by both owners and renters on an ongoing monthly basis to cover the costs for roadway maintenance and other transportation needs established by the locality. In effect, the fee “treats the transportation system like a utility in which residents and businesses pay fees based on their use of the transportation system”.3
The SBA also clarified that a borrower’s entire electricity bill is eligible for loan forgiveness, including electricity supply charges and electricity distribution charges, even if charged separately by the public utility.
Loan Forgiveness Reductions
A reduction in full-time equivalent (FTE) employees During the Covered Period may reduce the amount of loan forgiveness received unless safe harbor applies
The FAQs reiterate the rules governing lower forgiveness based on reductions in employees during the Covered Period, as further described in our client alert above. To be able to exclude any reduction in FTE employees in calculating its loan forgiveness amount, a borrower must document in good faith an inability to: (i) rehire individuals who were employees of the borrower on February 15, 2020 and (ii) hire similarly qualified individuals for unfilled positions on or before December 31, 2020.
Businesses are required to document the written offer to rehire an individual, a written record of the offer’s rejection, and a written record of efforts to hire a similarly qualified individual. Further, borrowers are required to inform the applicable state unemployment insurance office of any employee’s rejected rehire offer within thirty days of the employee’s rejection of the offer.
Pay reductions greater than 25% during the covered period may reduce the amount of loan forgiveness received unless safe harbor applies
Consistent with prior guidance, if the salary or hourly wage of a covered employee4 is reduced by more than 25% during the Covered Period, the eligible forgiveness amount will be reduced based on the portion of reduced salary or hourly wage in excess of 25%. Thus, as long as 75% of salary or hourly wages is maintained, there will be no reduction of the eligible forgiveness amount. This reduction does not apply to borrowers that reduced salaries or wages of employees making less than $100,000 in 2019 in the period between February 15, 2020 and April 26, 2020 if they eliminate such reduction by June 30, 2020. Specifically, if the employee’s annual salary or hourly wage as of June 30, 2020 is equal to or greater than the annual salary or hourly wage as of February 15, 2020, the safe harbor is met and no reduction is made to forgiveness.5 For purposes of calculating reductions in the loan forgiveness amount, the borrower should only take into account decreases in salaries or wages but not other forms of compensation. The FAQs provide examples of fact patterns around wage reduction to assist borrowers with this guidance.
Timing of Loan Payments
If a borrower submits a timely loan forgiveness application, the borrower is not required to make any payments until the forgiveness amount is sent to the lender by the SBA
While most borrowers aim for 100% forgiveness, the PPP remains a loan until forgiveness is granted –as we have noted in our May 29th alert. Even then, the SBA has six years to review any loan. In the FAQs, the SBA clarifies that as long as a borrower submits a forgiveness application within 10 months after the end of the Covered Period, the borrower is not required to make any payments toward the loan until the forgiveness amount is remitted to the lender by the SBA. If the loan is fully forgiven, the borrower is not responsible for any payments. If all or a portion of the debt is not forgiven, then the borrower must pay the balance before the maturity date (with interest accruing from disbursement to SBA remittance of the forgiveness amount and through the repayment date).
August 11, 2020 Additions – EIDL
On August 11, 2020, the SBA added FAQs regarding the interaction between the EIDL and the PPP for borrowers that received funds under both programs. The EIDL program is a legacy program of the SBA which provides low interest loans to small businesses impacted by emergencies including natural disasters. The CARES Act expanded on the existing EIDL structure to allow small businesses to receive advance payments in the form of grants up to $10,000 ($1,000 per employee) within a few days of applying. Unlike the PPP, EIDL funds (including the $10,000 grant) carried few restrictions on usage and could be spent on nearly all working capital purposes (with forgiveness of the EIDL advance requiring that it be spent on certain uses resulting from the disaster). If the EIDL loan was used for payroll costs, the PPP loan was required to be used to refinance its EIDL loan. We discussed the EIDL in our initial client alert on the CARES Act here and subsequent changes here and here.
The FAQs reiterate that while borrowers can receive both PPP loan and a $10,000 EIDL grant (both of which are forgivable if certain conditions are met), the amount of forgivable PPP funds is reduced by the amount of the EIDL grant. As an example, if a business were to receive $50,000 in PPP funds and $5,000 in an EIDL grant, only $45,000 of the PPP funds may be forgiven (with the EIDL grant being eligible for forgiveness according to its terms). The remaining $5,000 of the PPP loan may be retained by the borrower but must be repaid under the terms of the PPP (or repaid immediately if the borrower would rather not retain the funds as a loan). In the event that the amount of a borrower’s EIDL grant exceeded the amount of its PPP loan, no amount is forgivable from the PPP (as the entirety of the EIDL grant is eligible for forgiveness under its terms). While there is some overlap in the allowable uses of funds, borrowers may not “double dip” and spend PPP and EIDL funds for a duplicate use at the same time. The FAQs note that lenders will be able to confirm whether a borrower has received EIDL funds under the SBA’s online forgiveness platform accessible to the lender.
Both parties in Congress have introduced plans to provide additional relief to taxpayers and small businesses. In May, House Democrats passed the “HEROES Act” which would provide $3 trillion in expanded state and federal benefits including new individual stimulus checks, expanded sick, family and medical leave, and modifications to the PPP, among other things. In July, Senate Republicans announced their own “HEALS Act” which provides for $1 trillion in expanded benefits. Should members reach a consensus before most borrowers proceed to the PPP forgiveness stage, we would expect the new law to provide additional clarity on the use of PPP funds and loan forgiveness. Moreover, the Senate bill in particular allows businesses with fewer than 300 employees that have experienced at least a 50% reduction in gross revenues to apply for additional PPP funding. We will provide further client alerts on any final Phase 4 bill including whether a 2nd round of PPP funding is ultimately approved.
1This directs the borrower to lines 6-8 of PPP Schedule A of the loan forgiveness application (SBA Form 3508 or lender equivalent). The application is located here.
2This directs the borrower to lines 7-8 of PPP Schedule A of the loan forgiveness application (SBA Form 3508 or lender equivalent). The application is located here.
4A “covered employee” is an individual who: (1) was employed by the borrower at any point during the Covered Period or Alternative Payroll Covered Period and whose principal place of residence is in the United States; and (2) received compensation from the borrower at an annualized rate less than or equal to $100,000 for all pay periods in 2019 or was not employed by the borrower at any point in 2019.
5See the Salary/Hourly Wage Reduction Safe Harbor described in the Loan Forgiveness Application (SBA Form 3508 or lender equivalent).
ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm of approximately 725 lawyers practicing throughout a network of 13 offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy and technology sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.