What Businesses Need to Know About Forgiveness Under the Paycheck Protection Program

On March 27, 2020, the U.S. Congress passed and the President signed into law the largest relief legislation in the history of the United States: the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The Act provides direct financial relief to individuals, patients, hospitals, healthcare providers and first responders, small businesses and distressed industries.

Included in this Act is up to $349 billion in loans under the Payroll Protection Program (PPP) for qualifying businesses. Most significant of these benefits is the potential to apply for loan forgiveness if the loan is used for certain specified purposes in accordance with the Cares Act. Below we break down the PPP program, who qualifies for forgiveness, and how forgiveness amounts are calculated.

The Payroll Protection Program

PPP loans are made to eligible small businesses, sole proprietors, independent contractors and other self-employed individuals under the Section 7(a) loan guaranty program of the Small Business Administration (SBA) for the period from February 15, 2020 to June 30, 2020 to support small businesses with funds to keep their workforce employed during the pandemic crisis.

Generally, the maximum loan amount per borrower under the PPP is equivalent to the lesser of: (a) $10 million, or (b) 2.5 times the borrower’s average monthly payroll costs incurred during the one-year period before the date on which the loan is made plus the outstanding amount of any loan under the SBA Emergency Injury Disaster Loan Program (EIDL) made between January 31, 2020 and the date on which the PPP loans are available to be refinanced.

Interest on PPP loans is capped at 1.00% per annum and have a term of two years for any amounts not forgiven. Repayment of amounts borrowed but not forgiven commences 6 months following disbursement of the loan proceeds. The SBA has discretion to defer repayment for a period of up to one year.

Loans extended under the PPP must be used to pay rent, mortgage, utilities and eligible payroll expenses. Businesses who receive disaster loan relief for purposes other than paying payroll and other costs described under the PPP are not prohibited from applying for PPP loans, however, once the borrower applies for and receives a PPP loan, the borrower must not apply for or receive any other PPP loan or any other SBA 7(a) loan for the same purposes through December 31, 2020.

Forgiveness of PPP Loans; Eligibility

PPP loans are eligible for forgiveness of an amount equal to the sum of payroll costs, mortgage interest payments, rent and utilities for the eight week period following the first disbursement of the PPP loan to the borrower. Lenders are required to make the first disbursement no later than 10 calendar days from the date of approval of the loan. Loan forgiveness may not exceed the principal amount of the loan.

Under the Interim Final Rule and Treasury Guidance, at least 75% of the amount forgiven must be attributable to payroll costs. The other 25% of the amount forgiven may have been used for interest (not principal) on covered mortgage obligation that existed prior to February 15, 2020, covered rent obligation for leases that were in effect before February 15, 2020, and covered utility payments for services that began before February 15, 2020. The purposes of these new guidelines is to encourage businesses to retain their employees. Accordingly, the amount of the loan available for forgiveness will be decreased if full-time headcount declines, or if salaries and wages fall.

PPP loan applicants should take note the SBA will direct borrowers to repay PPP loan proceeds for any purpose other than those listed immediately above. Borrowers that use PPP loan proceeds for an unauthorized purpose may be subject to additional criminal liability, such as charges for fraud. Moreover, if a shareholder, member, or partner of a PPP loan borrower uses PPP loan proceeds for unauthorized purposes, the SBA will have recourse against such shareholder, member, or partner for the unauthorized use.

Amounts forgiven under the PPP will be considered cancelled debt authorized under Section 7(a) of the Small Business Act, but the CARES Act specifically provides that such funds are not to be included as gross income for tax purposes.

Reductions to Amount of Forgiveness

The amount of funds eligible for forgiveness will be reduced for employers who terminate employees and reduce salaries or wages during the covered period. Employers who re-hire employees previously laid off or eliminate the salary and wage reductions prior to June 30, 2020 will not be penalized by the reduction requirements.

Accordingly, any reductions in full-time employment or salaries that took place between February 15, 2020 and April 26, 2020 can be “cured” and will not reduce the amount of loan forgiveness if the borrower eliminates the reduction in employees or the reduction in salary and wages, as applicable, by June 30, 2020. There is no requirement that the borrower rehire the same employees; hiring full-time equivalent employees is sufficient.

Furloughing an employee following February 15, 2020 will not jeopardize forgiveness of a loan covered by the PPP but will factor into (reduce) the amount of forgiveness of the loan if the furlough was not otherwise exempt. The PPP’s exemption from reduction of the amount of loan forgiveness for borrower’s employees will allow an employer to “cure” (and the amount of forgiveness will not be reduced) if the employees furloughed by the employer after February 15, 2020 are re-hired by June 30, 2020.

Calculation of Payroll Costs and Employees

In general, for purposes of calculating the amount of PPP loans to be forgiven, borrowers may calculate aggregate payroll costs using data from either the previous 12 months or from calendar year 2019. For seasonal businesses, the borrower may use its average monthly payroll for the period between February 15, 2019 or March 1, 2019 and June 30, 2019. A borrower that was not in business from February 15, 2019 to June 30, 2019 may use its average monthly payroll costs for the period from January 1, 2020 through February 29, 2020.

The average number of full-time equivalent (FTE) employees of a borrower to be used for calculation of forgiveness may be determined by a borrower using the same periods referred to above. Alternatively, borrowers may use the SBA’s usual calculation, which is the average number of FTE employees of a business per pay period in the 12 completed calendar months prior to the date of the borrower’s loan application (or, in the event that the borrower has not been operational for 12 months, the average number of FTE employees for each of the pay periods that the borrower has been operational).
Below are examples of how to calculate the amount to be forgiven, as reduced based on employee reduction:

  • Non-seasonal employers: Forgiveness amount x (the average number of FTE employees per month between February 15, 2020 and June 30, 2020 ÷ the average number of FTE employees per month between February 15, 2019 and June 30, 2019 or January 1, 2020 and February 29, 2020 at the election of the borrower).
  • Seasonal employers: Forgiveness amount x (the average number of FTE employees per month between February 15, 2020 or March 1, 2019 and June 30, 2020 ÷ the average number of FTE employees per month between February 15, 2019 or March 1, 2019 and June 30, 2019).

The loan forgiveness amount will also be reduced by the amount of any reduction in total salary or wages of any employee that is in excess of 25% of the total salary or wages of the employee during the most recent full quarter before the covered period. This does not apply for individuals who, in any single pay period, received wages at an annualized rate of pay over $100,000.

Amounts forgiven under the PPP will be excluded from gross income calculations for purposes of the Internal Revenue Service Code of 1986, as amended.

Requirements to Request Forgiveness

Borrowers seeking loan forgiveness under the PPP must submit to the lender the following documentation:

  • Documentation verifying the number of full-time employees on payroll and the pay rates for the periods described above, including state income, payroll and unemployment insurance filings.
  • Cancelled checks, payment receipts, transcripts of accounts or other documents verifying payments on covered mortgage obligations, lease obligations and covered utility payments.
  • Certification from an authorized representative of the business that the documentation is true and correct, and that the amount for which forgiveness was requested was used to retain employees, make interest payments on covered mortgage obligations, rent payments or utility payments.
  • Any other documentation required by the SBA.

Lenders must issue decisions on the debt forgiveness applications within 60 days after the date the lenders receive debt forgiveness requests.

The SBA has been given 15 days following enactment of the PPP to issue governing regulations and 30 days to issue guidance on the loan forgiveness aspects of the PPP specifically. To date, the SBA has provided few guidelines, and even the guidelines the SBA has provided have been fluid.

The full text of the CARES Act may be found at: https://www.congress.gov/bill/116th-congress/senate-bill/3548/text

The Interim Final Rule may be found at: https://www.sba.gov/sites/default/files/2020-04/PPP–IFRN%20FINAL_0.pdf.

The Treasury Guidance may be found at: https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequenty-Asked-Questions.pdf.

Additional information on the Paycheck Protection Program may be obtained from the local SBA Field Office online at: https://www.sba.gov/tools/local-assistance/districtoffices.

Michael Smith works with lenders and borrowers in transactions involving automobile dealerships, community associations, construction projects, and government contracting, along with SBA loans. For more information, you can reach him at 301-657-0166 or [email protected].