As we’re all finding out with the various efforts to help businesses survive the pandemic-caused downturn, simple ideas do not necessarily lead to simple solutions, and efforts to fix the problems created by those not-so-simple solutions can often lead to unintended consequences. Case in point are two issues arising out of the recently-signed Paycheck Protection Program Flexibility Act (PPPFA), which was intended to give businesses more time to incur forgivable expenses. In doing so, however, a change in a defined term could undermine a cap on compensation and overturn SBA-created caps for employee-owners and the self-employed.
The simple idea behind the Paycheck Protection Program (PPP) created by the CARES Act was for the federal government, using forgivable PPP loans, to fund key operational expenses (payroll costs, mortgage interest, rent and utilities) of eligible businesses for the “covered period” (originally defined as eight weeks from the PPP loan origination). PPP loans would bridge from an economic shutdown that started in February to a happier and healthier time when the economy would be fully reopened.
Congress drafted the CARES Act when many did not expect COVID-19 to continue into the summer — that COVID-19 perhaps would miraculously disappear. The reality of reopening the economy has proved more difficult. In response to businesses needing more time to incur forgivable expenses, Congress passed the PPPFA, which achieved the extension by changing the definition of “covered period” from eight weeks from the PPP loan origination date to the earlier of (1) 24 weeks from the origination date or (2) the origination date to December 31. (Borrowers can elect to retain the original eight week covered period if they so choose.) Read our discussion in this article. Changing a defined term used throughout a statute can have other, potentially unintended consequences. We discuss two in this article:
A PPP loan equals two-and-a-half times a business’s 2019 average monthly payroll costs, with the cash compensation component of payroll costs capped at $100,000 per employee. Under the CARES Act, forgivable payroll costs also include this cap, “as prorated for the covered period.” For example, the PPP loan forgiveness application conforms to this requirement providing: “the total amount of cash compensation eligible for forgiveness may not exceed an annual salary of $100,000, as prorated for the Covered Period; therefore, do not enter more than $15,385.” (Emphasis added).
The SBA determined the $15,385 amount by prorating $100,000/year over an eight-week period - $15,385 = ($100,000/52)*8. Prorating for a 24-week covered period results in about $46,154 (($100,000/52)*24). At first blush, you may think this is not problematic because the PPP loan attributable to “high earner” cash compensation cannot exceed $20,833 (($100,000/12)*2.5), creating a natural cap of $20,833. Plus, the business presumably needs some of the $20,833 for the non-payroll costs.
This, however, does not take into account the SBA’s favorable guidance on calculating full-time equivalents (e.g., the ability to treat any employee who worked less than 40 hours per week as 0.5 FTE), calculating a reduction in compensation (e.g., no reduction for hourly workers if hourly rate stays the same despite a decrease in hours), or disregarding the lack of certain former employees (now codified in the PPPFA). We discussed the favorable guidance in this article.
Suffice it to say, and without getting into the details of the moving parts, it seems possible that a business with a few high-salary executives (over $100,000) and many low-wage, hourly employees could use PPP loan proceeds from the hourly workers to pay the executives (or a subset of the executives because the CARES Act itself provides that there is no reduction in forgiveness for a reduction in compensation of someone who makes over $100,000 per year). This likely becomes easier to justify to the extent the hourly employees opt to receive enhanced unemployment benefits, rather than return to work.1
As we discussed in this article, the SBA created additional limits on forgivable cash compensation paid to two categories of individuals: “employee-owners” and the self-employed, with the self-employed divided into two subcategories, sole proprietors and partners. Although the exact cap for each of the three differ, each incorporates 8/52 of 2019 compensation. For example, in discussing forgivable payroll costs for these categories, the PPP loan forgiveness application provides:
“This amount is capped at $15,385 (the eight-week equivalent of $100,000 per year) for each individual or the eight-week equivalent of their applicable compensation in 2019, whichever is lower.”
As described above, the SBA calculated $15,385 by prorating a $100,000 annual salary over the eight-week “covered period.” In discussing the cap on “employee-owners” and the self-employed, the SBA refers to eight weeks, but not the “covered period.” Presumably, however, the SBA used eight weeks because the CARES Act, for purposes of forgiveness, defined the covered period as eight weeks. Now that the PPPFA has amended the CARES Act to redefine the covered period, the SBA will need to revise these caps to take into account the longer covered period. Now virtually all sole proprietors and partnerships are more likely to secure forgiveness of their entire PPP loan amount.
This does not resolve all detrimental impacts of the SBA created limitations — for example, the cap for an “employee-owner” who did not earn 2019 compensation remains unclear. However, by increasing the covered period from eight weeks to 24 weeks, Congress largely nullified the impact of these limitations so long as the employee-owner worked for the same business in 2019 at a reasonably high salary.
1 In addition, the per employee $15,385 limit for cash compensation provides an important protection for lower-wage workers. Many business have continued to pay employees at a rate above $100,000 per year. An eight-week covered period meant that these businesses could not receive forgiveness for cash compensation above $15,385 per employee. This potentially prevented full forgiveness of the PPP loan without increasing the compensation of employees receiving less than $15,835 in eight weeks. As we discussed in this article, the SBA specifically described how such increases qualified for forgiveness. The ability to obtain forgiveness for more of the compensation already paid to employees making more than $100,000 generally decreases the need to find other forgivable costs.
Before proceeding, please note: If you are not a current client of Lane Powell PC, please do not include any information in this email that you or someone else considers to be confidential or secret in nature. Prior to the establishment of a lawyer-client relationship, unsolicited emails from non-clients containing confidential or secret information cannot be protected from disclosure.