Section 1102 of the CARES Act created the Paycheck Protection Program (PPP), which is intended to provide funds for small businesses affected by COVID-19 to maintain their workforce. The loans are forgivable under Section 1106 of the CARES Act if the loan is used for permitted payroll, rent, mortgage interest, and utilities expenses and certain workforce and salary maintenance thresholds are met. To apply for the loans, employers must make a number of certifications, including that economic uncertainty due to COVID-19 makes the loan necessary to support ongoing business operations. Additional certifications are required to apply for loan forgiveness. The use of loan proceeds, as well as whether the loan was necessary, is subject to audit by the Small Business Administration (SBA).
The roll-out of the program has been marked by uncertainty and frequent changes over how key terms are being interpreted in guidance and regulations released by the SBA and posted on the Treasury Department’s website. This has made it challenging for some employers, especially those who have already conducted layoffs or furloughs, to determine if the loan will be forgiven, in whole or in part, and what steps should be taken to maximize forgiveness. To further complicate implementation, on June 5, 2020, Congress enacted the Payroll Protection Program Flexibility Act (PPP Flexibility Act). The PPP Flexibility Act introduced substantial changes to the program, particularly with respect to forgiveness. On June 16 and June 17 SBA published revisions to the Third and Sixth Interim Final Rules, revised Loan Forgiveness Application Instructions, a Revised Forgiveness Application, and a new EZ Forgiveness Application and accompanying instructions that may be used under specified circumstances. Revised Loan Forgiveness Regulations were issued on June 22, 2020.
With the rules applicable to the program changing regularly, it is important always to confirm the latest guidance before moving forward with any decisions about participation in the program or use of the proceeds.
Who Can Apply?
Small businesses with 500 employees or fewer, including sole proprietorships, independent contractors and self-employed persons, 501(c)3 nonprofits, 501(c)(19) veterans organizations or Tribal business concerns affected by COVID-19 may apply for a covered loan. Accommodation and food services businesses qualify if they employ 500 or fewer employees per physical location.
Businesses with more than 500 employees may be eligible if they meet certain existing size and revenue rules used by the SBA. In addition, businesses who currently have more than 500 employees may be eligible if their number of employees is less than 500 using the calculation rules discussed below.
Eligibility for businesses with related entities is determined using SBA affiliation rules as modified by the CARES Act. For more information on the affiliation rules applicable to PPP, see our Private Equity Alert.
Businesses must have been in operation on February 15, 2020 to be eligible to apply for a loan. In the FAQs, which as of the date of this alert, were last updated May 27, 2020, SBA clarified that a change in the ownership of the business will not prohibit loan eligibility. If the acquiring business has maintained the operations of the pre-sale business, it may rely on the historic payroll costs and headcount of the pre-sale business for purposes of its PPP application, except where the pre-sale business applied for and received a PPP loan.
The original Interim Final Rule provided that a PPP loan will not be approved if an owner of 20% or more of the equity of the applicant has been convicted of a felony within the last five years. On June 12, 2020, SBA issued Additional Revisions to First Interim Final Rule (Additional Revisions) to limit the disqualifying felonies to those that involve fraud, bribery, embezzlement, or a false statement in a loan application or application for federal financial assistance. The Additional Revisions also reduced the look back period from five years to one year to determine eligibility for applicants, or owners of applicants, who, for non-financial felonies, have (1) been convicted, (2) pleaded guilty, (3) pleaded nolo contendere, or (4) been placed on any form of parole or probation (including probation before judgment). The eligibility requirements with respect to pending charges was revised on June 24, 2020. Previous regulations disqualified an owner of 20 percent or more of the equity of the applicant if they were subject to an indictment, criminal information, arraignment, or other means by which formal charges are brought at the time of the application. The Additional Eligibility Revisions limited the disqualifying pending criminal charges to only those for felony offenses.
How Do I Calculate the Number of Employees?
This is one of the areas on which SBA guidance continues to conflict. On April 24, 2020, the SBA issued How-to-Calculate-Loan-Amounts for different types of entities. It directs employers to use their calendar 2019 payroll and benefit expenses. Both before that date and in its FAQs, however, the SBA has given most employers a choice of what time period to use “for the purpose of applying an employee-based size standard.” It appears that the SBA is permitting employers to use alternate calculations to make themselves eligible for PPP loans, even though one calculation method would yield more than 500 employees, provided that another permitted method yields fewer than 500 employees.
Determining Who Are Employees. For determining the 500-employee threshold, the term “employee” includes individuals employed on a full-time, part-time, or other basis. It also includes student employees, other than state or federal work-study students. Businesses are required to include the employees of all “affiliates,” including foreign affiliates, in their own count. Affiliates is a defined term under existing SBA regulations, which the CARES Act modified in some ways. The term includes entities controlled by the business or under common control with the business (see link above for more details on the affiliation rules).
Independent contractors of the business cannot be counted as “employees.” Rather, independent contractors may apply separately based on their own compensation and benefits expenses.
Alternative Counting Methods. Under the FAQs, the number of employees may be measured using any of the following methods: (1) average number of employees for the last 12 months; (2) average number of employees for 2019; or (3) average number of employees per pay period in the 12 completed calendar months before the loan application.
Seasonal businesses may use the average number of employees from February 15, 2019 or March 1, 2019 through June 30, 2019. Under regulations issued on April 27, 2020, they can also choose to use average total monthly payments for payroll during any consecutive 12-week period between May 1, 2019 and September 15, 2019.
Businesses that have been in operation for less than 12 months can use either their average monthly employees for January 1, 2020 through February 29, 2020 or the average number of employees for each of the pay periods the business has been operational.
It has been, at times, difficult to keep up with the evolving guidance. Accordingly, it appears that some lenders are still permitting employers to use only the 2019 average or only the last 12 months, rather than giving employers the option that the FAQs provides. Borrowers should consult their lenders to understand what documentation the lenders are requiring for the application, as the documentation likely will need to support the number of employees listed on the application.
Employees vs. Full-Time Equivalents (FTEs). In the FAQs, the SBA confirmed that the 500-employee threshold for the loan is based on total employees, not FTEs. Loan forgiveness, on the other hand, is based on FTEs, as discussed below.
Why Does the Calculation Method Matter?
Selecting the number of employees to include on the application is important, as it may impact eligibility for certain businesses. As discussed below, the Loan Forgiveness Application requires employers to list the number of employees at the time of the original application, as well as the number at the time of the Loan Forgiveness Application. The purpose of this requirement is unclear because loan forgiveness is based on FTEs, not employees, and different measuring periods can be used, at the election of the borrower, for determining the number of FTEs for loan forgiveness. It is possible, but by no means clear, that this information is intended to allow SBA to assess borrower eligibility given the changing guidance related to workforce count over the past several weeks. Neither the Loan Forgiveness Regulations nor the Interim Final Regulations on SBA Loan Review Procedures (SBA Loan Review Regulations) address this issue. Similarly, neither the Loan Forgiveness Application nor the Loan Forgiveness Regulations address how to calculate the number of employees at the time of the Loan Forgiveness Application – is it a snapshot taken on the date the application is signed, a snapshot as of the last payroll date before the application is submitted, or an average calculated similar to the way the employee number was on the original loan application (such as an average over the last 12 months), or some other method?
It is worth noting that, although the FAQs permit the same periods to be used to calculate payroll costs for determining the amount of the loan, the guidance suggests that employers could use two different methods for determining the number of employees and the amount of payroll costs. This is particularly important for employers that already have done workforce reductions (prior to applying for the loan), as the time period selected for calculating payroll costs may determine whether they can use the proceeds in accordance with the program’s mandates. Employers with growing workforces, by contrast, may want to use the method that leads to the highest number so that they can use the proceeds to cover as much of their payroll costs as possible. This is discussed further below.
What Is the Application Window?
The deadline to apply for a PPP loan is June 30, 2020.
What Must Borrowers Certify in the Loan Application?
In addition to obligations to answer questions within the application truthfully, an applicant must explicitly certify in good faith, among other things:
- that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant;”
- that “funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments;”
- that the applicant understands that “if the funds are knowingly used for unauthorized purposes, the federal government may hold [the applicant] legally liable, such as for charges of fraud;”
- that the applicant will provide the lender documentation of the number of FTEs on the payroll as well as documentation for the permissible uses of the loan proceeds; and
- that the applicant has not received or applied for another SBA loan for similar reasons during the covered period.
- that not more than 40 percent of the forgiven amount may be used for non-payroll costs.
Sole proprietors, independent contractors, and self-employed individuals must submit documentation, including payroll tax filings, Forms 1099-MISC, and income and expenses. For borrowers that do not have any such documentation, they must provide other supporting documentation, such as bank records, sufficient to demonstrate the qualifying payroll amount.
If PPP funds are used for unauthorized purposes, the borrower will be required to repay those amounts. Additional penalties will be charged if funds are knowingly used for unauthorized purposes. Further, the SBA fact sheet states, “if the proceeds are used for fraudulent purposes, the U.S. government will pursue criminal charges against you.”
Recent regulations and guidance by SBA in the FAQs are focused on whether borrowers, including those with access to liquidity, can make the required certification of necessity for the loan. Borrowers had until May 18, 2020 to repay the loan proceeds without facing penalties if they concluded that the loan was not “necessary” under the FAQs. The SBA will presume that borrowers with loans under $2 million made the certification in good faith. Borrowers with loans in excess of $2 million that have access to other sources of funds should review the emerging guidance on this issue carefully. SBA has also announced that it will review the files for all loans of $2 million or more (and other files when it deems appropriate) when they are submitted for forgiveness, further increasing the pressure on large borrowers to insure that they can satisfy the necessity certification. If SBA determines that the loan was not necessary, it will demand repayment and deem the borrower not eligible for forgiveness. If the borrower repays the loan, SBA will not pursue criminal or other penalties. SBA’s review of loan is discussed further, below.
Treasury has announced that it will disclose the names and amounts of all borrowers that received more than $150,000. The disclosure will include business names, addresses, NAICS codes, zip codes, business type, demographic data, non-profit information, jobs supported, and loan amount based on ranges the following ranges: $150,000-350,000; $350,000-1 million; $1-2 million; $2-5 million; and $5-10 million.
What Are the Loan Period, Interest Rate, and other Terms of the Loans?
Applicants should view this as a loan program with the possibility, but not the guarantee, of forgiveness. Any loan amounts not forgiven will have a one percent interest rate. Loans made after the enactment of the PPP Flexibility Act have a five-year maturity, instead of the two-year maturity established by SBA regulatory guidance. For loans made prior to the PPP Flexibility Act, lenders and borrowers may agree to apply the five-year term. The date that SBA assigns a loan number to the PPP loan is the date the loan is considered “made” for purposes of determining the applicable maturity period. The PPP Flexibility Act also extended the deferral period, during which interest accrues but no payments have to be made, from six months following the end of the covered loan period to the date on which the amount of loan forgiveness is remitted to the lender or, if the borrower has not applied for forgiveness by this time, 10 months after the covered loan period ends. Interest continues to accrue during the deferral period. The loan is guaranteed by the federal government so there is no requirement for a personal guarantee or collateral. In addition, the borrower is not subject to any loan fees and there is no prepayment penalty.
Assuming proper use of proceeds, loan amounts, including both principal and deferred interest, are 100 percent forgivable subject to the limitations discussed below.
How is the Loan Amount Calculated?
Businesses can borrow a maximum of 2.5 times their average monthly payroll costs, up to $10 million. The SBA’s Interim Final Rule, as modified by the FAQs, provides the following steps for calculating payroll costs:
Step 1: Aggregate payroll costs (defined below) for employees whose principal place of residence is the United States. Most borrowers can choose to aggregate their payroll costs for either the 12 months before the loan application or calendar year 2019. Seasonal businesses may use average monthly payroll for February 15, 2019 or March 1, 2019 through June 30, 2019 or during any consecutive 12-week period between May 1, 2019 and September 15, 2019. Borrowers who were not in business from February 15, 2019 to June 30, 2019 may use their average monthly payroll costs for January 1, 2020 through February 29, 2020.
Step 2: Subtract any cash compensation paid to an employee in excess of $100,000 annualized. For independent contractors or sole proprietors, subtract any cash compensation earned in excess of $100,000 per year.
Step 3: Calculate average monthly payroll costs (divide the amount from Step 2 by Step 1).
Step 4: Multiply the average monthly payroll costs from Step 3 by 2.5.
Step 5: Add the outstanding amount of an Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020, less the amount of any “advance” under an EIDL COVID-19 loan (because it does not have to be repaid).
Payroll costs include the following compensation and benefits paid to employees or on behalf of employees:
- the gross amount of salary, wage, commission, or similar compensation (presumably, this includes bonuses, although they are not mentioned in the statute, regulations or FAQs about calculating loan amounts);
- payment of cash tips or equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate of such tips);
- payment for vacation, parental, family, medical, or sick leave;
- allowance for dismissal or separation;
- payment required for the provisions of group health care benefits, including insurance premiums;
- payment of any retirement benefit; and
- payment of state or local tax assessed on the compensation of employees.
For independent contractors and sole proprietors, includable payroll costs are the sum of payments of any compensation or income that is a wage, commission, income, net earnings from self-employment, or similar compensation and that is in an amount that is not more than $100,000 in one year prorated. The following are expressly excluded from the payroll cost calculation:
- cash compensation paid to an individual employee in excess of an annual salary of $100,000 including payments such as housing allowances, prorated for the period to be covered by the loan (i.e. amounts in excess of $8,333.33 per month). This includes any payments made to an employee, such as a housing allowance, but not contributions for retirement benefits or health care benefits paid on behalf of an employee;
- payments made by a business to its independent contractors;
- payroll, FICA, and other federal taxes imposed or withheld from employee compensation (the FAQs explain that borrowers should not deduct federal taxes withheld from their payroll calculations, but also cannot add the employer tax amounts to their calculations);
- any compensation of an employee whose principal place of residence is outside of the United States;
- qualified sick leave wages for which a credit is allowed under section 7001 of the Families First Coronavirus Response Act (FFCRA); or
- qualified family leave wages, for which a credit is allowed under section 7003 of the FFCRA.
What Can The Loan Be Used For?
The PPP Flexibility Act extends the “Covered Period” in which borrowers can use loan proceeds from eight weeks to 24 weeks. Borrowers who received their disbursement prior to the enactment of the PPP Flexibility Act may choose to use either the eight or 24 weeks starting with disbursement of the loan as the Covered Period or, for payroll and benefit costs, an “Alternative Payroll Covered Period” (discussed below) that starts on the first day of the first pay period following disbursement of the loan. The Covered Period must end no later than December 31, 2020.
The loan may be used to pay for the following costs incurred or paid during the Covered Period (or Alternative Payroll Covered Period) on behalf of employees (even if they are furloughed during that time):
- payroll costs using the above definition;
- costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums;
- employee salaries, commissions, or similar compensation which is not in excess of $100,000 per year annualized;
- interest on mortgage obligations that were in place before February 15, 2020 (but not mortgage premiums);
- rent under lease agreements in force before February 15, 2020;
- utilities for which service began before February 15, 2020; and
- payment of interest on certain pre-existing debt obligations.
In addition, borrowers who received EIDL loans between January 31, 2020 and April 3, 2020 may use PPP loan proceeds to refinance those loans and must refinance any amounts of the EIDL loan used to cover payroll costs.
Cash compensation is limited to a maximum of $15,385 per individual over an eight-week Covered Period ($100,000 annualized). If the borrower uses a 24-week Covered Period, the maximum total cash compensation that can be counted towards forgiveness for any employee is $46,154. In either case, borrowers can only include compensation for people who were employed during the Covered Period or Alternative Payroll Covered Period and whose principal place of residence is in the United States. This includes any amounts paid out for sick leave or vacation, as well as any severance amounts. In addition, cash compensation for owner-employees, general partners, and self-employed individuals (including independent contractors) can be no more than the amount they earned on average in eight weeks in 2019, or, for a 24-week Covered Period, the lesser of $20,833 or 2.5 months of 2019 compensation. (discussed further, below).
Utility costs include water, gas, electric, phone, internet, and transportation. Transportation has not been defined; however, in the April 14 Interim Final Rule, which primarily addresses calculations for independent contractors and sole proprietors, SBA mentioned costs such as gas for a business vehicle. Therefore, it appears that gas for company-owned vehicles are included. It would not appear to extend to the cost of the vehicles themselves or maintenance or insurance, although it may extend to vehicle leases under that guidance. The Revised Loan Forgiveness Application and Loan Forgiveness Regulations offer no further guidance on defining transportation costs.
Under the PPP Flexibility Act, at least 60 percent of the loan proceeds must be used to pay for permissible payroll costs in order to qualify for forgiveness. The Revised First Interim Final Rule interprets this requirement as a proportional limit on non-payroll costs as a share of the borrower’s loan forgiveness amount, rather than as a threshold for receiving any loan forgiveness. It is important to note that all use of the loan proceeds remains subject to the permissible uses of the loan, and failure to do so may be considered an improper use of the loan proceeds, subjecting the borrower both to civil and criminal penalties.
What is the Timing of Costs Incurred and Paid?
Payroll Costs. Under the Loan Forgiveness Application and Loan Forgiveness Regulations, borrowers are eligible for forgiveness if they use the loan proceeds for “costs incurred” or paid during the Covered Period.
As noted above, the Loan Forgiveness Application introduced the concept of an Alternative Payroll Covered Period, which borrowers may elect to use for payroll costs instead of measuring the loan period from the date of initial disbursement. The Alternative Payroll Covered Period is the eight-week or 24-week period beginning on the first day of the first pay period following the initial loan disbursement date. For example, if the loan proceeds were disbursed on Monday, April 20, and the first day of the payroll period following disbursement is Sunday, April 26, the Alternative Payroll Covered Period would run from April 26 through June 20 for an eight-week loan. This eliminates the need to run special payroll periods for employers with bi-weekly payroll or who receive the disbursement in the middle of payroll period. This Alternative Payroll Covered Period also applies to benefits costs. It does not apply, however, to non-payroll costs, such as mortgage interest, rent, and utilities. The Revised Loan Forgiveness Application clarifies that borrowers may still use the Alternative Payroll Covered Period following the PPP Flexibility Act.
Payroll costs are considered paid on the day that paychecks are distributed or on the date the ACH credit transaction is originated. For employees who are being paid but not working, the payroll costs are considered to be incurred when the employee otherwise would have worked. Payroll costs incurred but not paid during the last pay period of the Covered Period (or Alternative Payroll Covered Period) are eligible for forgiveness if paid on or before the next regular payroll date.
Eligible Non-Payroll Costs. The period for calculating rent, mortgage interest, and utilities payments cannot be adjusted based on the Alternative Payroll Covered Period approach. However, there is added flexibility for including these costs as well. Borrowers can include expenses paid during the Covered Period, and those 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. In other words, covered costs must be “paid or incurred” during the Covered Period. SBA provides a helpful example in the Loan Forgiveness Regulations:
A borrower’s covered period begins on June 1 and ends on July 26. The borrower pays its May and June electricity bill during the covered period and pays its July electricity bill on August 10, which is the next regular billing date. The borrower may seek loan forgiveness for its May and June electricity bills, because they were paid during the covered period. In addition, the borrower may seek loan forgiveness for the portion of its July electricity bill through July 26 (the end of the covered period), because it was incurred during the covered period and paid on the next regular billing date.
These calculations do not permit prepayment of expenses, such as future rent, mortgage interest, utilities, or other covered expenses that are not yet due (e.g., paying January’s rent in October).
What Documentation is Required for Loan Forgiveness?
The borrower must document the use of the proceeds and make additional certifications in order to apply for forgiveness. The April 14 Interim Final Rule provides:
In addition to the borrower certification required by Section 1106(e)(3) of the Act, to substantiate your request for loan forgiveness, if you have employees, you should submit Form 941 and state quarterly wage unemployment insurance tax reporting forms or equivalent payroll processor records that best correspond to the covered period (with evidence of any retirement and health insurance contributions). Whether or not you have employees, you must submit evidence of business rent, business mortgage interest payments on real or personal property, or business utility payments during the covered period if you used loan proceeds for those purposes.
It also imposes additional requirements for the self-employed claiming lost profits.
Borrowers must submit the following documentation with the Loan Forgiveness Application as it has now been revised:
- PPP Loan Forgiveness Calculation Form or PPP Loan Forgiveness Calculation Form 3508EZ (discussed below);
- PPP Schedule A, unless the borrower qualifies to file the EZ Forgiveness Application (discussed below); and
- Payroll documentation verifying cash compensation and non-cash benefits payments made during the Covered Period (or Alternative Payroll Covered Period), consisting of:
- Bank account statements;
- Federal and state tax forms; and
- Payment receipts, cancelled checks, or account statements documenting employer contributions to employee health insurance and retirement plans that were included in the forgiveness amounts.
- Unless the borrower qualifies to file the EZ Forgiveness Application, FTE documentation showing:
- The average number of FTEs on payroll per month between February 15, 2019 and June 30, 2019;
- The average number of FTEs on payroll per month between January 1, 2020 and February 29, 2020; or
- In the case of seasonal employers, either of these periods or any consecutive 12-week period between May 1, 2019 and September 15, 2019.
- Non-payroll documentation verifying the existence of obligations/services prior to February 15, 2020 and eligible payments during the Covered Period.
Borrowers who complete the full Forgiveness Application also are required to complete and maintain the PPP Schedule A Worksheet that is included in the Forgiveness Application. Table 1 of the Worksheet requires borrowers to compile a list of each individual employee’s cash compensation, average FTE, and salary or hourly rate reduction, if applicable. Table 2 requires a listing of each individual employee who received cash compensation of more than $100,000 in 2019. The Schedule A Worksheet has a FTE Reduction Safe Harbor section which must be completed, if applicable (discussed below). In addition, the instructions contain a worksheet on the wage reduction calculations and safe harbor (discussed below).
In addition to these specific documentation requirements, borrowers must maintain all documentation submitted with the PPP loan application, supporting the certifications made, supporting material compliance with PPP requirements. Borrowers also must maintain records showing any job offers and refusals, firings for cause, voluntary resignations, written requests by any employee for reductions in work schedule, and documents supporting a decrease in business operations due to compliance with COVID-19 related regulations (discussed below). All documentation must be maintained and available for inspection by SBA for six years after the date the loan is forgiven or paid in full.
The PPP Flexibility Act extended the deadline for filing a loan forgiveness application to 10 months following the end of the Covered Period. If the borrower does not apply for forgiveness within 10 months following the end of the Covered Period, or if SBA determines that the loan is not forgivable (in whole or in part), the loan is no longer deferred and borrowers must begin paying principle and interest. Borrowers do not need to wait until the end of the Covered Period to apply for loan forgiveness if all the proceeds for which forgiveness is sought have been spent. However, if a borrower applies for forgiveness before the end of the Covered Period, but has reduced salary or wages by more than 25 percent, the excess reduction must be accounted for through the entire eight or 24 weeks of the Covered Period.
How Do Borrowers Determine Which Forgiveness Application to Use?
Borrowers can use the EZ version of the Loan Forgiveness Application if any one of the following are true:
- The borrower is self-employed, an independent contractor or sole proprietor and didn’t include any employee salaries in calculating payroll for the application;
- The borrower did not reduce annual salary or hourly wages of any employee (not counting anyone who made more than the equivalent of $100,000 annualized in any pay period in 2019) by more than 25 percent during the Covered Period or Alternative Payroll Covered Period compared to the period January 1 through March 31, 2020 and did not reduce the number of employees or average paid hours between January 1, 2020 and the end of the Covered Period, ignoring (1) any reductions based on inability to rehire anyone who was employed on February 15, 2020 if the borrower could not hire a replacement by December 31, 2020 and (2) any reductions in hours that were offered to restore and the employee refused; or
- The borrower didn’t reduce annual salary or hourly wages of any employee (not counting anyone who made more than the equivalent of $100,000 annualized in any pay period in 2019) by more than 25 percent during the Covered Period or Alternative Payroll Covered Period compared to the period January 1 through March 31, 2020 and was unable to operate during the Covered Period at the same level of business activity as before February 15, 2020 due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020 by the Secretary of Health and Human Services, the Director of the Centers for Disease Control, or the Occupational Health and Safety Administration for COVID-19 health and safety requirements.
For the second scenario, it appears that borrowers likely will not know whether they can use the EZ Form until after December 31, 2020, although, as discussed below, the Revised Loan Forgiveness Application allows borrowers to determine whether other safe harbors apply as of the earlier of the date they submit their loan forgiveness application or December 31, 2020. It is not clear whether the same is true of this exception to the FTE reduction rules discussed below. The same certifications are required on the EZ Loan Forgiveness Application as on the Loan Forgiveness Application (discussed below), plus a certification that either bullet two or three above applies. Borrowers must maintain documentation that supports their ability to use the EZ Form, including the public health orders on which they rely.
How Does the Loan Forgiveness Work?
The details of how loan forgiveness will be calculated and subject to reduction has been one of the biggest areas of uncertainty.
Similar to the original forgiveness application, the Revised Loan Forgiveness Application includes the Loan Application Form, PPP Schedule A, and the PPP Schedule A Worksheet, borrower certifications (discussed below), and documentation requirements (discussed above). Borrowers are instructed to complete Schedule A and the Worksheet to compute eligible compensation for each employee, the number of FTEs for the covered period, and the applicability of forgiveness reductions and the savings provision. The EZ Loan Forgiveness Application dispenses with Schedule A and the Schedule A Worksheet in favor of a far more streamlined form.
In order to achieve full forgiveness of the loan under the PPP Flexibility Act, employers must do all of the following: (1) use at least 60 percent of the total amount of the loan on qualifying payroll and benefit costs during the Covered Period or Alternative Payroll Covered Period, (2) spend the remaining loan proceeds of not more than 40 percent of the total loan amount on qualifying rent, mortgage interest, and utility payments during the Covered Period, and (3) not have their forgiveness reduced based on reductions in FTEs or employees’ wages or salaries, discussed below, or qualify for one of the safe harbors discussed below. Not satisfying any of these requirements will result in reduction of the loan forgiveness amount. In addition, the amount of any EIDL advance will be deducted.
Use of Loan Proceeds. PPP loans are 100 percent forgivable if all the proceeds are used for qualifying payroll and benefit costs (using the definitions above), and permitted mortgage interest (but not principal), rent, and utility payments during the Covered Period, provided that at least 60 percent of the proceeds are used for qualifying payroll and benefit costs during that period..
Cash Compensation. Cash compensation paid to an employee cannot exceed $15,385 for an eight week Covered Period or Alternative Payroll Covered Period (the equivalent of annual pay of $100,000 for eight weeks), or $46,154 during a 24 week Covered Period or Alternative Payroll Covered Period. That specifically includes wages, commissions, paid time off, and severance. The Loan Forgiveness Regulations further include hazard pay and bonuses in cash compensation. This provides flexibility for employers managing their workforces through this crisis in two ways. First, employers trying to incentive people to work are not limited in their ability to provide hazard pay or make up for lost tips or commissions (subject to the cash compensation cap). Second, if employers need to lay off employees again at the end of Covered Period or Alternative Payroll Covered Period, they will not risk losing forgiveness by paying those employees severance in a lump sum at the end of the period, so long as the employees’ total compensation, including the severance, does not exceed the cash compensation cap.
The loan forgiveness amount for owner-employees, self-employed individuals and general partners is capped at the lesser of 8/52 of the 2019 compensation (approximately 15.38 percent of 2019 compensation) or $15,385 per individual in total across all businesses if using an eight week Covered Period. Under a 24 week Covered Period, the cap is the lesser of $20,833 or 2.5 months of 2019 compensation. Owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement and health care contributions made on their behalf. Schedule C filers are capped by the amount of their owner compensation replacement, calculated based on 2019 net profit. General partners are capped by the amount of their 2019 net earnings from self-employment (reduced by claimed section 179 expense deduction, unreimbursed partnership expenses, and depletion from oil and gas properties) multiplied by 0.9235. No additional forgiveness is provided for retirement or health insurance contributions for self-employed individuals, including Schedule C filers and general partners, as such expenses are paid out of their net self-employment income.
Deduction of EIDL Advances. If the borrower also received an EIDL loan advance up to $10,000, the SBA will deduct the amount of that advance from the forgivable amount of the loan.
What Factors Can Result in Reduction of Loan Forgiveness?
Workforce Measures. The amount of loan forgiveness is proportionally reduced if employers reduce their FTEs, or if they reduce employees’ salaries or wages by more than 25 percent (not including compensation for employees who earn more than $100,000) against certain pre-loan measures, unless those reductions are restored by December 31, 2020 (extended from June 30, 2020 by the PPP Flexibility Act). Under the Loan Forgiveness Application, the salary or wage reductions are calculated first.
In the Loan Forgiveness Regulations, SBA makes clear that reductions involving the same employee will not be double-counted. For example, reducing an employee from 40 hours a week to 20 hours per week will be considered taking an employee from 1.0 FTE to 0.5 FTE, but will not also be considered a 50 percent reduction in the employee’s salary or rate of pay.
Compensation Reduction and Forgiveness. The amount of forgiveness is reduced by the amount of reduction in total salary or wages for each employee of more than 25 percent during the loan period compared to the pre-loan baseline wages and salary. The baseline is the salary and wages earned by the employee during the last completed calendar quarter before the loan period (i.e. First Quarter 2020). Employees who earned the equivalent of $100,000 annualized ($8,333.33 per month) during any pay period in 2019 are not included in this calculation.
Under the Loan Forgiveness Application, borrowers compare the average annual salary (for salaried employees) or hourly rate (for hourly employees) during the Covered Period or Alternative Payroll Covered Period to the average salary or rate in Q1 2020. A decrease in loan forgiveness only occurs if that average salary/hourly rate for each employee is reduced by more than 25 percent. These calculations are done on an individual basis and the amount of loan forgiveness is reduced by the amount that each employee’s salary/hourly rate was reduced by more than 25 percent, unless the savings provision discussed below applies. The Loan Forgiveness Regulations provide a helpful example:
A borrower reduced a full-time employee’s weekly salary from $1,000 per week during the reference period to $700 per week during the covered period. The employee continued to work on a full-time basis during the covered period. In this case, the first $250 (25 percent of $1,000) is exempted from the reduction. Borrowers seeking forgiveness would list $400 as the salary/hourly wage reduction for that employee (the extra $50 weekly reduction multiplied by eight weeks).
The same is true of borrowers with a 24-week Covered Period (i.e., the weekly reduction amount is multiplied by 24). The calculations of this reduction for salaried employees and hourly employees are detailed separately in the Revised Loan Forgiveness Application.
If a borrower who has reduced salary/hourly rates by more than 25 percent submits their loan forgiveness application before the end of their 24-week Covered Period, and the saving provision does not apply, the borrower still must reduce the forgiveness amount by the full 24 weeks. Using the example above, if the borrower exhausts the loan funds after 12 weeks of their 24-week Covered Period and decides to submit their loan forgiveness application at that time, the borrower would list $1,200 as the salary/hourly wage reduction for that employee (the extra $50 weekly reduction multiplied by 24 weeks). Notably, although not specifically defined, the Loan Forgiveness Application’s calculation method suggests that only base salary or hourly wage rate will be considered for calculating reductions, as opposed to a comparison of total cash compensation. For employers that provide significant amounts of compensation through bonuses, commissions, or other revenue sharing measures, this distinction is critical and eliminates the problem posed by bonuses or commissions paid in Q1 2020 that could have inflated compensation for that time period. Note, however, that the Revised Loan Forgiveness Application does not address this issue directly, nor do the Loan Forgiveness Regulations.
FTE Reduction and Forgiveness. The amount of forgiveness will be reduced by multiplying the otherwise forgivable loan amount (i.e. the amount spent on permissible expenses less any EIDL advance) by the proportion of employment loss. Employment loss for forgiveness purposes is based on FTEs, not workforce headcount. Employment loss is calculated by determining the quotient of average number of FTEs each pay period during the Covered Period or Alternative Payroll Covered Period divided by pre-loan FTEs. To calculate its pre-loan FTEs, an employer can use either (a) its average number of FTEs from January 1, 2020 to February 29, 2020, or (b) its average number of FTEs from February 15, 2019 to June 30, 2019. Under the Loan Forgiveness Application, seasonal employers can use either of these time periods or any consecutive 12-week period between May 1, 2019 and September 15, 2019 to measure their FTEs. For example, if the resulting quotient is 90 percent, the employer’s loan forgiveness is reduced by 10 percent (unless adjusted based on the savings provisions discussed below).
The Loan Forgiveness Application details how to calculate FTEs. For each employee, take the average number of hours paid per week, divide by 40, and round the total to the nearest tenth. The maximum for each employee is capped at 1.0. Alternatively, a simplified method is to assign a 1.0 for employees who work 40 or more hours per week and 0.5 for employees who work fewer hours. The borrower must pick one of these methods and apply it consistently.
Once the employer calculates FTEs during the Covered Period or the Alternative Payroll Covered Period, they are compared to determine if the total amount of potential forgiveness is reduced. For example, if an employer’s FTEs are 50 percent lower during the loan period than they were during the selected pre-loan measuring period, the amount of loan forgiveness is reduced by 50 percent, subject to the additional reductions and the savings provisions described below. Because of the significant impact that it may have on determining the amount of forgiveness, employers should carefully consider how to structure both any changes in their workforce related to the loan period and which measuring period to choose. For example, it appears that employers could decide to consolidate part-time positions into full-time positions to maintain or increase their number of FTEs, even as they reduce total headcount and, potentially, benefit costs. From the text of the CARES Act, and the calculation method in the Loan Forgiveness Application, doing so would not appear to trigger reduction in forgiveness.
Notably, employees do not count as an FTE reduction if either of the following are true: (i) the borrower made a written offer to restore an employee’s hours, and salary or wage rate during the Covered Period or Alternative Covered Period and the employee rejected the offer; or (ii) during the Covered Period or Alternative Covered Period, the employee voluntarily resigned, was fired for cause, or voluntarily requested and received a reduction in hours. In either of these circumstances, the borrower must maintain documentation and provide it to SBA upon request. In each of these cases, the employee does not count as an FTE only if the position was not filled by a new employee. Note that this only provides employers with relief on the reduction in FTEs—it does not allow borrowers to count what the excluded employee would have earned as salary or wages toward the compensation forgiveness reduction component. Finally, these provisions apply only to employees who leave employment or refuse an offer to return during the Covered Period or Alternative Payroll Covered Period. They do not apply to employee separations or refusals that occur before the loan period begins. The PPP Flexibility Act also added two broader “safe harbors” from FTE reduction penalties, discussed below.
The Loan Forgiveness Regulations make clear that there is no requirement that the employees actually perform work during the loan period. The purpose of the PPP loans is to keep people on payroll and off unemployment so paying people not to work is acceptable.
The reductions in potential forgiveness based on decreased FTEs and on pay reductions are cumulative, which can limit employer options to account for costs that are not covered by PPP while facing revenue reductions. For example, businesses that are struggling to pay for insurance costs, inventory, and other fixed and variable expenses may need to reduce expenses that PPP loans do not cover. Yet, seeking to reduce those expenses by reducing employee compensation or headcount may threaten the ability to receive loan forgiveness and, therefore, add to the financial strain on the business.
What “Savings Provisions” and “Safe Harbors” Can Borrowers Use to Ameliorate Forgiveness Reductions?
Savings Provision for Reduction Window. The CARES Act includes a “savings” provision that allows businesses that conducted layoffs or furloughs or salary reductions for one or more employees between February 15, 2020 and April 26, 2020 (the reduction window) to receive the full amount of forgiveness to which they would otherwise be entitled provided that: (i) any reduction in FTEs that occurs during the reduction window is restored by the earlier of the date the loan forgiveness application is submitted or December 31, 2020 (extended from June 30, 2020 by the PPP Flexibility Act) to at least the number of FTEs employed on February 15, 2020; and/or (ii) the reduction in average annual salary or hourly wage for each employee compared to February 15, 2020 has been restored by the earlier of the date the loan forgiveness application is submitted or December 31, 2020 (extended from June 30, 2020 by the PPP Flexibility Act). Reductions occurring after April 26, 2020 cannot be “saved” under these provisions, which is consistent with the expectation that PPP funds will be use to preserve employment and compensation for employees.
Notably, the Revised Loan Forgiveness Application contains separate worksheets for employers to determine if they qualify for these so-called “safe harbors” against reductions in loan forgiveness and allows employers to qualify for them separately. In other words, employers can qualify for one or the other or both.
Borrowers are exempt from the reduction in forgiveness for salary/hourly wage reductions that occurred between February 15, 2020 and April 26, 2020, if wage levels are restored by the earlier of the date they submit the loan forgiveness application or December 31, 2020. The calculation of whether this safe harbor applies and, if not, what impact it has on loan forgiveness is a multi-step process:
- First, the Revised Loan Forgiveness Application requires borrowers to determine if there was a reduction of more than 25 percent in the salary or wages of any employee (who earned less than $100,000 annualized in 2019, as discussed above). If no employee had their average salary or hourly wage reduced by more than 25 percent, there is no reduction and nothing more needs to be done.
- If one or more employees did suffer such a reduction, the employer next compares that employee’s average annual salary (for salaried employees) or hourly wage (for hourly employees) on February 15, 2020 with the average for that employee during the February 15 to April 26, 2020 reduction window. If the amount during the reduction window is the same or greater, the next step is to calculate the amount of the reduction in forgiveness because the Safe Harbor does not apply.
- If the average annual salary or hourly wage during the reduction window is less than it was on February 15, 2020, it is next compared to the average annual salary or hourly wage on the earlier of the date the loan forgiveness application is submitted or December 31, 2020. If that average is greater than or equal to the average on February 15, 2020, the Safe Harbor has been satisfied, and there is no reduction in forgiveness. If not, the next step is to calculate the amount of the reduction in forgiveness following the separate instructions in Loan Forgiveness Application for salaried and hourly employees.
Note that there is no minimum amount of reduction that disqualifies an employer from taking advantage of the Safe Harbor for any given employee if that employee suffered a reduction in salary/wage rate that triggers the loss of forgiveness, and their average annual salary or hourly rate on the earlier of the date the loan forgiveness application is submitted or December 31, 2020 is less than it was on February 15, 2020.
Safe Harbor for Decreased Business Activity. The PPP Flexibility Act includes an additional Safe Harbor which provides that borrowers unable to return to business levels are exempt entirely from a reduction in forgiveness based on FTE levels. The amount of loan forgiveness shall be determined without regard to reduction of FTEs if the loan recipient can document in good faith the inability to return to the same level of business activity it had on February 15, 2020 due to compliance with regulations and guidance issued by the Secretary of Health and Human Services, the CDC, or OSHA during the period March 1 to December 31, 2020 related to employee or public health or safety under COVID-19. While on its face, this does not cover compliance with state and local requirements that exceed the federal guidance, the Revised Loan Forgiveness Regulations read this broadly to include both direct and indirect guidance, recognizing that much of the decreased business activity is the result of following state and local public health orders that are based, in part, on CDC, OSHA, and HHS guidance. Borrowers must maintain documentation supporting their inability to operate at the same level of business activity, relevant financial records, and copies of the compliance requirements or guidance that caused the decrease in business activity.
Safe Harbor for FTE Reductions. The PPP Flexibility Act includes another safe harbor which eliminates a reduction in loan forgiveness that would otherwise be required due to a reduction in FTEs. Specifically, the amount of loan forgiveness is not reduced if a borrower is able to document in good faith (i) an inability to rehire individuals who were employees on February 15, 2020, and (ii) an inability to hire similarly qualified individuals for unfilled positions on or before December 31, 2020. The Loan Forgiveness Regulations add the requirement that, for employees who refuse a written offer to return, the borrower must inform the state unemployment insurance office within 30 days of the rejection. Borrowers must maintain documentation of 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.
Impact on Timing of Filing for Loan Forgiveness. Borrowers struggling with the forgiveness reduction calculations can wait until after December 31, 2020 to file their loan forgiveness application, making sure to stay within the 10-month period following the end of their Covered Period, in order to take full advantage of the cure opportunities under the PPP Flexibility Act, even if they are using an eight week Covered Period that ends long before that date. Conversely, borrowers who have restored FTEs and/or salary/wage rates and can qualify for savings provisions or the Safe Harbor for decreased business activity, but anticipate they will be making additional reductions in pay or hours, may want to submit their loan forgiveness applications as soon as possible.
Open Questions. The Loan Forgiveness Application and Loan Forgiveness Regulations, have resolved a number of areas of uncertainty, but, without further guidance, open questions remain, including the following:
- For the employee’s average annual salary or wage rate on the earlier of the date the loan forgiveness application is filed or December 31, 2020, does the employee actually have to be paid that amount by December 31, 2020, or just that the employee’s wage rate must be restored by that date, even if they have not actually earned the money? If they must have been paid that amount, over what period of time?
- If an employer—such as a school or an employer that operates a school-year program—does not layoff or furlough employees during the reduction window, and they do not resign or are terminated for cause, but the employer nevertheless loses a significant portion of its employees during the loan period based on the scheduled end of employment when the academic or program period ends, will it still have its amount of forgiveness proportionally reduced?
With the loan period used to determine the amount of forgiveness beginning when the loan proceeds are received, most employers applying for PPP loans have already made critical workforce decisions. As a result, for employers who already have spent the loan proceeds before the enactment of the PPP Flexibility Act, the changes may have come too late.
What Certifications are Required for Forgiveness?
An authorized representative of the borrower must make several certifications on the Revised Loan Forgiveness Application:
- The amount requested for forgiveness was (1) used to pay costs eligible for forgiveness, (2) includes all applicable reductions due to decreases in FTEs and salary/hourly wage reductions, (3) does not include non-payroll costs in excess of 40 percent of the amount requested, (4) includes payroll costs equal to at least 60 percent of the forgiveness amount, (5) if a 24-week covered period applies, does not exceed 2.5 months’ worth of 2019 compensation for any owner-employer or self-employed individual/general partner, capped at $20,833 per individual; and (6) if the borrower has elected an 8-week covered period, does not exceed eight weeks’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner, capped at $15,385 per individual.
- All payments for eligible payroll and non-payroll costs have been accurately verified. This includes an acknowledgement that the federal government may pursue recovery of loan amounts and/or civil or criminal fraud charges if the funds were knowingly used for unauthorized purposes.
- All required documentation has been submitted, and that the information provided in the application and supporting documents is true and correct. This section includes an acknowledgement that that making a false statement to obtain forgiveness is punishable under the law, including 18 USC 1001 and 2571 by imprisonment for up to five years and a fine up to $250,000; under 15 USC 645 by imprisonment for up to two years and a fine up to $5,000; and, if submitted to a federally insured institution, under 18 USC 1014 by imprisonment of up to 30 years and a fine up to $1,000,000.
- SBA may request additional information for evaluating eligibility the PPP loan and for forgiveness, and that failure to provide such information may result in a determination that the borrower was ineligible for the loan or a denial of the Loan Forgiveness Application.
- If the borrower checked the box for the FTE Reduction Safe Harbor based on reduced business operation, the borrower must certify that they qualify for the Safe Harbor.
The application representations and certifications on Page 2 of the revised Loan Forgiveness Application concludes with the following statement: “The Borrower’s eligibility for loan forgiveness will be evaluated in accordance with the PPP regulations and guidance issued by SBA through the date of this application. SBA may direct a lender to disapprove the Borrower’s loan forgiveness application if SBA determines that the Borrower was ineligible for the PPP loan” (emphasis added.) While the highlighted statement appears to evaluate eligibility in accordance with regulations and guidance issued as of the date the Loan Forgiveness Application was first published, the SBA Loan Review Regulations make clear that eligibility is based on information available at the time of the loan application, which is consistent with SBA FAQ 17, which provides, in part, that “Borrowers and lenders may rely on the laws, rules, and guidance available at the time of the relevant application.”
What is the Timeline for a Decision on Loan Forgiveness?
Each lender must confirm receipt of the borrower certifications on the Loan Forgiveness Application, confirm receipt of the relevant documentation, and confirm the borrower’s calculations. Lenders are to conduct a “minimal review” of the borrower’s calculations that are based on a payroll report by a recognized third-party payroll processor, and a “more extensive review” of calculations and data otherwise. A lender must issue a decision to SBA on a Loan Forgiveness Application within 60 days after a borrower submits the completed application. The decision may take the form of an approval (in whole or part), denial, or, if directed by SBA, a denial without prejudice due to a pending SBA review of the loan. In a case of a denial without prejudice, the borrower may request that the lender reconsider its application for forgiveness within 30 days of notice of the denial (unless SBA has determined that the borrower was ineligible for the loan in the first place). Within five days of the borrower’s request for review, the lender must notify SBA of the request. SBA will notify the lender if it declines the request, or if it accepts the request, SBA will notify the lender and the borrower of the results of the review.
If the lender determines that the borrower is entitled to some level of forgiveness, the lender must request payment from the SBA at the same the decision is submitted. Within 90 days of the submission, SBA will, subject to a review of the loan or loan application, remit the appropriate forgiveness amount to the lender, plus any interest accrued through the date of payment. If any portion of the loan is not forgiven, the borrower must repay the unforgiven portion within two years or five years of the loan maturity date, depending on the date of the loan and the agreement between the borrower and the lender.
SBA reserves the right to review the lender’s decision in its sole discretion.
Will Loans be Audited by SBA?
SBA has announced that it will audit every loan of $2 million or more at the time the lender submits the Loan Forgiveness Application to it. In addition, the SBA Loan Review Regulations make clear that SBA can audit any loan within six years after the loan is forgiven or repaid in full. SBA will review the following: (1) whether the borrower was eligible for the loan based on the law, the rules and guidance issued as of the time of the loan application, and the terms of the loan application, (2) whether the loan amount was correct and whether the loan proceeds were used properly, and (3) whether the borrower is entitled to the loan forgiveness claimed.
If it appears that a borrower may be ineligible to receive the loan amount or forgiveness amount claimed, borrowers will have the opportunity to respond to SBA questions and requests for information. If SBA determines a borrower is ineligible for a loan, it will not be forgiven. Similarly, if SBA determines that the borrower is not entitled to the forgiveness amount claimed, forgiveness will be denied in whole or in part, as applicable.
In the SBA Loan Review Regulations, SBA announced that it intends to issue a rule creating an appeal process for anyone found ineligible.
What Are the Tax Implications of the PPP Flexibility Act?
The PPP Flexibility Act removes the bar in the CARES Act on employers who have PPP loans forgiven from taking advantage of the CARES Act provisions permitting deferral of the payment of payroll taxes due between March 27, 2020 and January 1, 2021. Fifty percent of such deferred taxes are due December 31, 2021 and the other 50 percent are due December 31, 2022. More information about the payroll tax delay may be found in our CARES Act Tax Provisions Alert.
Notably missing from the PPP Flexibility Act is any language addressing the IRS pronouncement that expenses paid with forgiven PPP loan proceeds are not deductible for federal income tax purposes. See our PPP Tax Alert for more information. The lack of Congressional action gives credence to the IRS position.