HunterMaclean: Usage Reminders for the Paycheck Protection Program Loan
Tuesday, May 19th, 2020
Now that businesses have received or are in the process of receiving a Payroll Protection Plan (PPP) loan, review of the guidance is important, especially if the business will be seeking loan forgiveness. To assist businesses in their efforts to use their PPP funds appropriately, we offer the following as an orderly and useful compilation of existing guidance, including recent guidance issued on May 13, 2020.
HOW CAN PPP LOANS BE USED?
The proceeds of a PPP loan are to be used for:
Payroll costs (see Section 2).
Costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums.
Interest payments (but not principal or principal payments) on debt obligations incurred prior to February 15, 2020. In order to qualify for potential loan forgiveness, the interest has to be “covered mortgage interest,” which is interest in respect of a debt secured by real or personal property (i.e., “mortgage” debt) incurred prior to February 15, 2020.
Rent payments. In order to qualify for potential loan forgiveness, the payment must be for “covered rent,” which is defined as rent in respect of a lease agreement that was in effect prior to February 15, 2020.
Utility payments. In order to qualify for potential loan forgiveness, the payment must be “covered utilities,” which is defined as the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.
Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020. If your EIDL loan was used for payroll costs, your PPP loan must be used to refinance your EIDL loan. Proceeds from any advance up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan.
WHAT QUALIFIES AS “PAYROLL COSTS?”
Payroll costs consist of compensation to employees (whose principal place of residence is the United States) in the form of salary, wages, commissions, or similar compensation; cash tips or the 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 separation or dismissal; payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums, and retirement; and payment of state and local taxes assessed on compensation to employees.
Note, however, that qualified sick and family leave wages for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act (Public Law 116–127) are excluded from the definition of payroll.
Also excluded from the definition of payroll is the compensation of an individual in excess of an annual salary of $100,000, as prorated for the applicable measurement period (e.g., the period from February 15, 2020 to June 30, 2020 and, for loan forgiveness purposes, the 8-week period following the disbursement of the loan proceeds).
WHAT QUALIFIES FOR POTENTIAL LOAN FORGIVENESS?
The amount of the loan that potentially may be forgiven is the loan proceeds spent during the 8-week period on documented payroll costs, covered mortgage interest, covered rent payments, and covered utilities. Not more than 25% of the forgiven amount may be for non-payroll costs. To maximize potential loan forgiveness, you will want to use as much of the loan proceeds as you can during the 8-week period following the disbursement of the loan on payroll. (Note, the guidance indicates a separate requirement that you must use at least 75% of the funds on payroll.)
For purposes of determining the percentage of use of proceeds for payroll costs, the amount of any EIDL refinanced will be included.
While business groups and associations are lobbying to reduce the percentage used on payroll to 50%, you cannot count on that and should assume the status quo.
WHAT IS THE RELEVANT PERIOD FOR POTENTIAL LOAN FORGIVENESS?
The potential amount of forgiveness of a PPP loan depends on the amount of loan proceeds used on allowable expenses (payroll, covered mortgage interest, covered rent, and covered utilities) over an 8-week period. The 8-week period begins on the date the lender makes the first disbursement of the PPP loan to the borrower. The lender must make the first disbursement of the loan no later than 10 calendar days from the date of loan approval.
As of now, the SBA has been firm on covering only expenses from that 8-week window.
Note, the “potential” loan forgiveness amount is subject to 2 different “reduction tests.”
Under the Full-Time Equivalent (FTE) Reduction Test, the potential loan forgiveness amount may be reduced by a percentage equal to the difference between 1 minus the average monthly FTEs during the 8-week period following the disbursement of the loan proceeds and the average monthly FTEs during the “base period” (generally, at your election, either 2/15/19 to 6/30/19 or 1/1/20 to 2/29/20).
Under the Salary and Wages Reduction Test, the potential loan forgiveness amount may be reduced by the amount, if any, the salary and wages paid to an employee (excluding any employee who earned annualized salary and wages over $100,000 during any payroll period in 2019) during the 8-week period following the disbursement of the loan is less than 75% of the salary and wages paid to such employee during the most recent quarter prior to the date of the loan the individual was an employee.
If any positions that were eliminated, or hours or salary/wages rates that were reduced, during the period from 2/15/20 to 4/16/20 are restored by June 30, then for purposes of applying these “reduction tests” you will be treated as having such restored positions, hours, or salary/wages in effect during the 8-week period following the disbursement of the loan.
To the extent the loan proceeds are not forgiven, you have up to 2 years to repay the loan, at 1% interest. There is a 6-month payment deferral period for interest.
WHAT IS THE TAX CONSEQUENCE OF LOAN FORGIVENESS?
If funds are spent on qualifying expenses, the loan can be forgiven, and the amount forgiven will not be treated as taxable income. However, the expenses you pay with the proceeds of the loan that are forgiven are not deductible for tax purposes.
WHAT DOCUMENTATION IS REQUIRED FOR LOAN FORGIVENESS?
As noted above, more than 25% of the forgiven amount can be attributable to allowable items (such as covered rent, covered utilities, and covered mortgage interest) other than payroll during the 8-week period following the disbursement of the loan. Additionally, there is a separate requirement that 75% of the loan proceeds are used for payroll. The borrower will have to document the proceeds used for payroll costs and other allowable items in order to determine the amount of forgiveness.
As of May 14, the SBA has yet to issue detailed guidance on documenting loan forgiveness or the use of funds for allowable purposes (or the application of the FTE Reduction Test and Salary & Wages Reduction Test).
Based on the limited guidance issued to date, the borrower can submit a request for loan forgiveness to the lender that is servicing the loan following the 8-week period after disbursement of the loan proceeds. The request will include documents that verify the number of full-time equivalent employees and pay rates, as well as the payments on eligible mortgage, lease, and utility obligations. The borrower must certify that the documents are true and that the borrower used the forgiveness amount to keep employees and make eligible mortgage interest, rent, and utility payments. The lender must make a decision on the forgiveness within 60 days.
WHAT DOCUMENTATION PRACTICES SHOULD BE CONSIDERED?
In the absence of specific SBA guidance, the following practices should be considered.
Separate vs. Commingled Bank Accounts
Because the SBA has not issued guidance on documentation, we do not know whether the SBA will require specific tracing of the use of funds. Money is fungible. Thus, if specific tracing is required, it will be difficult to do if the PPP loan proceeds are deposited into an account containing other funds. Under the tax regulations, for example, when it is necessary to trace the use of funds in a commingled account, a “first-in, first-out” approach is taken. Whether the SBA would take a similar approach if tracing is required is not known. To avoid the issue, rather than commingle funds, until we have guidance on this, we have recommended that the PPP funds are deposited into a separate bank account just containing the PPP funds. To the extent payments of “allowable” items (such as payroll, rent, or utilities) can be made directly from such account, we would recommend doing so.
We understand oftentimes that payroll and other payments are already set up to be paid from the operating bank account, so direct payment may not be practicable. In that case, we are recommending that money is directly transferred to the operating bank account for the exact amount of the funds being paid from the operating account. Underlying documents also need to be retained to match the amounts, such as payroll records, utility invoices, etc. In the event an amount is transferred from the PPP bank account to the operating account to pay an expense that is later determined to be ineligible, the operating account could reimburse the PPP account for the exact amount of the ineligible item.
If you use a payroll provider, the easiest solution would be to reach out to your payroll provider to prepare reports showing the funds were used for payroll. In addition, provide bills and canceled checks for your rent, mortgage, utilities, or interest payments if you used the funds for those purposes. If you do not use a payroll company, then follow the outline of a Schedule C form with backup documentation to show how the money was spent. This can include canceled checks, bank transfers, and the payment of acceptable expenses.
Constantly track your FTE monthly average during the 8-week “covered period” as you will generally need to meet your average for the applicable test period described above to maximize loan forgiveness. Review compensation for employees to ensure that you do not reduce their pay beyond 25% of the base amount described above, as doing so reduces eligibility for loan forgiveness.
HOW WILL THE SBA REVIEW BORROWERS’ REQUIRED GOOD-FAITH CERTIFICATION CONCERNING THE NECESSITY OF THEIR LOAN REQUEST – LOANS UP TO $2 MILLION?
When submitting a PPP application, all borrowers must certify in good faith that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” SBA, in consultation with the Department of the Treasury, has determined that the following safe harbor will apply to SBA’s review of PPP loans with respect to this issue: any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.
SBA has determined that this safe harbor is appropriate because borrowers with loans below this threshold are generally less likely to have had access to adequate sources of liquidity in the current economic environment than borrowers that obtained larger loans. This safe harbor will also promote economic certainty as PPP borrowers with more limited resources endeavor to retain and rehire employees. In addition, given the large volume of PPP loans, this approach will enable SBA to conserve its finite audit resources and focus its reviews on larger loans, where the compliance effort may yield higher returns.
HOW WILL THE SBA REVIEW BORROWERS’ REQUIRED GOOD-FAITH CERTIFICATION CONCERNING THE NECESSITY OF THEIR LOAN REQUEST – LOANS OVER $2 MILLION?
Importantly, borrowers with loans greater than $2 million that do not satisfy this safe harbor may still have an adequate basis for making the required good-faith certification, based on their individual circumstances in light of the language of the certification and SBA guidance. SBA has previously stated that all PPP loans in excess of $2 million, and other PPP loans as appropriate, will be subject to review by SBA for compliance with program requirements set forth in the PPP Interim Final Rules and in the Borrower Application Form.
If SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. If the borrower repays the loan after receiving notification from SBA, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request. For purposes of this safe harbor, a borrower must include its affiliates to the extent required under the interim final rule on affiliates, 85 FR 20817 (April 15, 2020).
Though not included in the SBA guidance issued on May 13, 2020, the following might be factors in support of a good-faith certification and should be documented accordingly:
Necessity and uncertainty based on the date of your loan application
Due diligence completed in connection with making the certification
Impact of COVID-19 and social distancing on staffing, service delivery, etc.
Cash/Liquidity—outline available cash (unrestricted) from all sources (including LOCs) and the need for those reserves
Forecasting exercise of future operations before and with COVID 19
Specific workforce/labor dynamics, alternative service delivery, debt covenants, etc.
Lost future sales, canceled orders, and uncertainty about the length of the shutdown
However, it may be problematic in an audit if you used PPP loan funds to essentially increase capital or create a surplus. In general, larger purchases—equipment, expansion, etc.—that are not essential during this time could be expected to be viewed unfavorably. Any expenditures outside of keeping your facility open or your employees paid can be expected to cause concern.
WHAT IS THE SBA GUIDANCE REGARDING RETURN OF A LOAN?
An SBA interim final rule posted on May 8, 2020 provided that any borrower that applied for a PPP loan and repays the loan in full by May 14, 2020 will be deemed by SBA to have made the required certification concerning the necessity of the loan request in good faith.
On May 14, the SBA extended the repayment date for this safe harbor to May 18, 2020, to give borrowers an opportunity to review and consider the guidance it issued on May 13, 2020 (see Section 8 and Section 9 above). Borrowers do not need to apply for this extension.
HOW IS LOAN FORGIVENESS REQUESTED?
You can submit a request to the lender that is servicing the loan. The request will include documents that verify the number of full-time equivalent employees and pay rates, as well as the payments on eligible mortgage, lease, and utility obligations. You must certify that the documents are true and that you used the forgiveness amount to keep employees and make eligible mortgage interest, rent, and utility payments. The lender must make a decision on the forgiveness within 60 days.
IN ADDITION TO THE FOREGOING, WHAT ARE SOME OF THE COMMONLY ASKED QUESTIONS REGARDING PPP LOAN FORGIVENESS AND USE?
Will a borrower’s PPP loan forgiveness amount (pursuant to section 1106 of the CARES Act and SBA’s implementing rules and guidance) be reduced if the borrower offered to rehire an employee who had been laid off, but the employee declined the offer?
No. SBA and Treasury intend to issue an interim final rule excluding laid-off employees whom the borrower offered to rehire (for the same salary/wages and same number of hours) from the CARES Act’s loan forgiveness reduction calculation. The interim final rule will specify that, to qualify for this exception, the borrower must have made a good-faith, written offer of rehire, and the employee’s rejection of that offer must be documented by the borrower. Employees and employers should be aware that employees who reject offers of re-employment may forfeit eligibility for continued unemployment compensation.
If I laid off workers, do I need to rehire the same employees to meet the payroll requirement?
No. Your bank will not check to see if you hired the same employee back, but simply that your payroll amount is the same or greater than the 2019 average upon which the loan amount was based.
Do I need to hire the same position or keep employees in the same jobs?
No. Again, your lender will be looking at the amount you spent on payroll, not who fills what job. However, note that the position must be a full-time employee and not a contractor in order to count towards forgiveness.
Is June 30 an important deadline?
Yes, if your objective is to have the loan forgiven. You can mitigate the potential negative impact of the FTE reduction tests and salary and wages reduction tests on the loan forgiveness amount if, by June 30, 2020, you restore any positions eliminated or hours or salary and wage rates reduced between February 15, 2020 and April 26, 2020.
The CARES Act excludes from the definition of payroll costs any employee compensation in excess of an annual salary of $100,000. Does that exclusion apply to all employee benefits of monetary value?
No. The exclusion of compensation in excess of $100,000 annually applies only to cash compensation, not to non-cash benefits, including: employer contributions to defined-benefit or defined-contribution retirement plans; payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums; and payment of state and local taxes assessed on compensation of employees.
Do PPP loans cover paid sick leave?
Yes, except to the extent you are eligible for a tax credit for such leave under sections 7001 and 7003 of the Families First Coronavirus Response Act (Public Law 116–127).
PPP loans generally can be used for payroll costs, including costs for employee vacation, parental, family, medical, and sick leave. However, as previously noted, the definition of “payroll” excludes qualified sick and family leave wages for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act (Public Law 116–127).
What if an eligible borrower contracts with a third-party payer such as a payroll provider or a Professional Employer Organization (PEO) to process payroll and report payroll taxes?
SBA recognizes that eligible borrowers that use PEOs or similar payroll providers are required under some state registration laws to report wage and other data on the Employer Identification Number (EIN) of the PEO or other payroll provider. In these cases, payroll documentation provided by the payroll provider that indicates the amount of wages and payroll taxes reported to the IRS by the payroll provider for the borrower’s employees will be considered acceptable PPP loan payroll documentation. Relevant information from a Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, attached to the PEO’s or other payroll provider’s Form 941, Employer’s Quarterly Federal Tax Return, should be used if it is available; otherwise, the eligible borrower should obtain a statement from the payroll provider documenting the amount of wages and payroll taxes. In addition, employees of the eligible borrower will not be considered employees of the eligible borrower’s payroll provider or PEO.
How should a borrower account for federal taxes when determining its payroll costs for purposes of the maximum loan amount, allowable uses of a PPP loan, and the amount of a loan that may be forgiven?
Under the Act, payroll costs are calculated on a gross basis without regard to (i.e., not including subtractions or additions based on) federal taxes imposed or withheld, such as the employee’s and employer’s share of Federal Insurance Contributions Act (FICA) and income taxes required to be withheld from employees. As a result, payroll costs are not reduced by taxes imposed on an employee and required to be withheld by the employer, but payroll costs do not include the employer’s share of payroll tax. For example, an employee who earned $4,000 per month in gross wages, from which $500 in federal taxes was withheld, would count as $4,000 in payroll costs. The employee would receive $3,500, and $500 would be paid to the federal government. However, the employer-side federal payroll taxes imposed on the $4,000 in wages are excluded from payroll costs under the statute.