Many businesses that received paycheck protection program (PPP) loans are several weeks into the eight-week period (Covered Period) for which payroll costs, mortgage interests, rent and utilities (Forgivable Costs) can result in forgiveness of the PPP loan. The SBA now has released its long-awaited Loan Forgiveness Application (the Application) for PPP loans. The Application provides welcome guidance that helps resolve key ambiguities in the CARES Act rules on forgiveness, the forgiveness provisions in the (first of nine) Interim Final Rules published in the Federal Register on April 15 (IFR), and how the statute and the IFR work together.
Of course, for any program as massive as PPP loans, some issues will remain unclear, creating uncertainty for many businesses in completing the Application. Nonetheless, the Application provides favorable guidance, possibly on par with FAQ #46, which we discussed in this article.
The key takeaways from the Application include:
The CARES Act allows for forgiveness of “costs incurred and payments paid” for Forgivable Costs during the Covered Period. However, it was unclear whether the word “and” was meant to be conjunctive or disjunctive. For example:
As discussed in this article, we generally advised that it made sense to interpret “and” as disjunctive with respect to payroll costs that is, as if Congress used “or” but warned that the issue was unclear. With its definition of “Cash Compensation,” the SBA has resolved this issue by adopting the more favorable, disjunctive interpretation.
This could materially increase payroll costs depending on when a business received its PPP loan. For example, if a business received a PPP loan on April 29, and pays payroll on the 15th and last day of each month, with paychecks cut on April 30, then the business effectively gets an extra 13 days of payroll forgiven. Similarly, if the eight-week period for this business ends on June 25 (five days before paychecks are cut), the business receives forgiveness credit for payroll costs incurred through June 25 without having to run an extra payroll. The business effectively receives forgiveness credit for close to 10 weeks of payroll costs. We appreciate the favorable result (and simplicity for calculations), but note the disparate treatment depending on whether the bank disbursed the PPP loan shortly before or shortly after a payroll period.
In our prior article, we also warned that this treatment may not apply to the other Forgivable Costs because Congress used the word “payment” in discussing each of these. In the Application, however, the SBA allows for forgiveness for mortgage interest, rent and utilities to amounts paid during the Covered Period and costs “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.”
Nothing in the Application requires a special treatment for bonuses or other nonrecurring payments included in gross wages. Accordingly, it generally appears that businesses can increase payroll costs by accelerating bonuses or paying new bonuses. We always thought that allowing businesses to use bonuses to increase payroll costs made sense because a business only benefitted from this with respect to employees who received less than $15,385 during the Covered Period. That is, there is a $15,385 per employee limit on cash compensation for which a business obtains forgiveness. For example, a $1,000/week employee who receives a $10,000 bonus (i.e., $18,000 during the Covered Period) results in $15,385 of payroll costs for purposes of forgiveness.
It appears that businesses can similarly accelerate and increase employer contributions to retirement plans and health plans. Because these are not subject to the $15,385 cap, the allowance for forgiveness for these payments is less clear.
Payroll costs include compensation paid to “owner-employees/self-employed individual/general partners.” Businesses were ultimately encouraged/allowed to include these amounts in payroll costs (to the extent the income was characterized as attributable to self-employment) for purposes of the PPP loan application, even if not reported as wages (e.g., included on Form 941). Inclusion of these amounts in payroll costs for forgiveness makes sense.1
The Application instructs a business to “[e]nter the amount of business rent or lease payments for real or personal property during the Covered Period, pursuant to lease agreements in force before February 15, 2020” and to “[e]nter the amount of business utility payments during the Covered Period, for business utilities for which service began before February 15, 2020.” Unlike mortgage interest, these instructions are silent on prepayments (the CARES Act specifically prohibits forgiveness for prepayments of mortgage interest). They also are silent about late payments. Accordingly, it appears that businesses can obtain forgiveness of late payments and prepayments of rent and utilities made during the Covered Period. The SBA’s rule limiting 25 percent of the forgivable amount to non-payroll costs, discussed below, generally should prevent abuse with respect to late payments and prepayments. Nonetheless, businesses should review lease terms and discuss the matter with their tax advisors to confirm whether these payments will result in forgiveness.
The CARES Act contains two reductions in forgiveness (one for a reduction in headcount based on applying a ratio of full time equivalent employees (the FTE Ratio) to total Forgivable Costs and one for a reduction in compensation). The CARES Act also caps forgiveness at the principal amount of the PPP loan. In IFR 2(o), the SBA limited the forgivable amount to payroll costs during the covered period divided by 75 percent. It was unclear how these different limitations worked together. The Application provides a clear ordering rule pursuant to which the forgivable amount is the least of:
In so doing, the Application, consistent with the CARES Act, also rejects suggestions in both the IFR and Senator Rubio’s PPP explanations (on his website) that interest accrued during the eight-week period might also be forgiven.
As describe above, the Covered Period generally will not match a business’s payroll periods. The Application provides flexibility by allowing certain businesses to use the “Alternative Payroll Covered Period.” Only businesses with a biweekly or more frequent payroll period may use the Alternative Payroll Covered Period accordingly, this does not apply to businesses that use a monthly payroll period or a twice a month payroll period. The Alternative Payroll Covered Period is the eight-week period beginning on the first day of the first pay period which starts during the Covered Period.2 All other Forgivable Costs are calculated based on the Covered Period. If a business uses the Alternative Payroll Covered Period, all references to the Covered Period with respect to payroll costs means the Alternative Payroll Covered Period.
This generally makes payroll cost calculations easier for businesses that have biweekly or more frequent pay periods. However, this simplicity comes at a cost: there will not be any payroll costs for work performed before the beginning of the Covered Period or Alternative Payroll Covered Period. Further, given the “paid or incurred” relief discussed above, the Covered Period and the pay periods not overlapping generally should not be a problem. Using the Covered Period may require more complicated calculations, but it also increases payroll costs.
The Application provides a mechanical formula, with employee-by-employee inputs, to determine the FTE Ratio. This generally appears to be user friendly. However, we have not yet had an opportunity to work through this formula with real world examples. We anticipate that questions will arise and hope that the SBA will update its PPP loan FAQs to provide guidance.
Business also may include in the numerator of the FTE Ratio FTEs not actually worked related to:
A business may only include these FTEs if the business did not fill the position with a new employee. This makes sense to avoid double counting. Importantly, there is no increase in payroll costs not actually paid for these former employees for purposes of the regulatory limit to the forgivable amount (payroll costs divided by 75 percent).
The Application provides a mechanical formula for calculating the reduction in forgiveness for a reduction in compensation that appears to be user friendly. We will have to see whether it actually is in practice. Importantly, for hourly workers, the formula in the Application basis is the reduction on a reduction hourly wage, regardless of a reduction in hours. Thus, for example, there is no reduction in forgiveness for a reduction in compensation if the business maintained the hourly rate, but paid for fewer hours.
Interestingly, the SBA eschewed the statutory formula, which, as discussed in our prior article, is based on the excess of the reduction during the Covered Period over 25 percent of the amount paid to the employee in the first quarter of 2020. This would have allowed a reduction of just over 40 percent without detrimental consequences to the business. Instead, a reduction in forgiveness occurs if the business reduces an employee’s compensation by more than 25 percent compared to the first quarter of 2020. This is perhaps understandable, given the widespread discussion of this provision as preventing a reduction in compensation of more than 25 percent. We also do not know if this reduction in forgiveness beyond the amount described in the CARES Act will have a material impact, given the regulatory limit on the forgivable amount (payroll costs divided by 75 percent). Nonetheless, we would not be surprised to see litigation about the SBA’s calculation.
The CARES Act provides that the statutory reductions in forgiveness based on the FTE Ratio or a reduction in compensation do not apply if the business fully restores the applicable reduction by June 30. The Application provides a mechanical formula for determining if the business made the necessary restoration with respect to each reduction. The Application takes into account the FTEs and compensation levels, as applicable, on June 30. A business thus can avoid both statutory reductions by restoring the reductions on a single day. In the extreme, this means that a business has no statutory reduction in forgiveness if it shuts down all operations during the covered period and restores all payroll just on June 30. The regulatory limit to the forgivable amount (payroll costs divided by 75 percent) generally should prevent this type of abuse and gaming, though we anticipate a brief spike in employment between June 29 and July 1.
As demonstrated by FAQ 39 and FAQ 46, the SBA has adopted a policy of subjecting PPP loans in excess of $2 million to more scrutiny. In many situations, however, separate members of an affiliated group each received a PPP loan of $2 million or less, with the total received by the group exceeding $2 million. This raised questions as to how the SBA would enforce this policy when each loan has a unique SBA PPP loan number. The Application includes a box for businesses to check “If Borrower (together with affiliates, if applicable) received PPP loans in excess of $2 million.” Accordingly, each business applying for forgiveness must confirm whether it is part of an affiliated group that received PPP loans totaling more than $2 million. As indicated in our article about the affiliation rules, they can apply more broadly than a business would expect.
The Application contains seven representations and certifications about the requested forgiveness which provide some insight into the standards by which SBA will be reviewing PPP loans and forgiveness requests. For example, #2 requires businesses to represent and certify that they “understand that if the funds were knowingly used for unauthorized purposes, the federal government may pursue recovery of loan amounts and/or civil or criminal fraud charges” (emphasis added). Additionally, businesses are required in #5 to certify that the information they have provided in the Application and the supporting documents is true and correct in all material respects and that they “understand that knowingly making a false statement to obtain forgiveness of an SBA guaranteed loan is punishable under the law [...]” This is consistent with the knowledge requirement for false claims act liability and may give businesses comfort that the government is truly looking for bad actors. On the other hand, these certifications were not required by the CARES Act and the SBA should not be creating substantive requirements via representations dropped into an administrative form.
The Application provides guidance on documents that must be (1) submitted to the lender along with the Application and (2) retained by the business but not submitted. The Application creates a high, but reasonable standard that is consistent with the documents needed for the PPP loan application.
We still have many questions about the computation of forgiveness, and many more questions will no doubt occur in the coming days. Recognizing this, the SBA, in its new release about the Application, announced that it “will also soon issue regulations and guidance to further assist businesses as they complete their applications, and to provide lenders with guidance on their responsibilities.” But for now, we are comfortable saying that the Application is a good start and is fairly favorable to businesses. For those seeking line by line guidance so they can complete the application, we highly recommend Toni Nitti’s guidance from this week’s Forbes, available here. 3
1 However, it will be incongruous if the partners received their own PPP loans because the partnership applied early in the PPP process before guidance was released about inclusion of partners’ self-employment income as a partnership’s payroll costs. See also IFR 9 (May 14, 2020) which allows those partnerships to file for additional funds.
2 It is helpful that the SBA provided this limited flexibility for payroll costs. Many businesses that remain shut down or largely shut down (e.g., retail shops, restaurants and hotels) have been pushing for discretion to select an eight-week period beginning after they reopen. The Application does not provide this relief.
3 We all owe Mr. Nitti a debt of gratitude. After completing a draft of this article, we read Mr. Nitti’s deep dive and concluded that we could shorten this article because his line by line instructions were so thoughtful.
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