Preparing for Paycheck Protection Program Loan Forgiveness
This article outlines the specific steps to take.
How to Apply for Loan Forgiveness
The CARES Act makes clear that the recipient of a PPP loan must apply to their lender for loan forgiveness. This application cannot be made any sooner than eight weeks after the loan originates. The U.S. Small Business Administration (SBA) has stated that it will issue additional guidance on the manner in which an application for forgiveness will be made.
Here are key points to be aware of:
- Up to 100% of a PPP loan may be forgiven.
- The loan forgiveness amount is determined by first computing the amount of payments made for qualifying payroll costs, mortgage interest payments (but not payments or prepayments of principal), rent payments, and utility payments for the eight-week period that begins on the date the lender makes the first disbursement of the PPP loan to the borrower.
For this purpose, qualifying payroll costs include:
- Salary, wages, commissions, or similar compensation;
- Cash tips or their equivalent;
- Payments for vacation, parental, family, medical, or sick leave;
- Severance payments;
- Employer payments for group health care coverage, including insurance premiums;
- Employer contributions to retirement plans; and
- Payments of state and local taxes assessed on employee compensation.
When computing cash tips, an employer may use records of past tips or, if there are no such records, a reasonable, good-faith employer estimate of employee tips. This is especially important for organizations that engage in an activity, such as a church coffee shop, where tips are an element of employee compensation.
Allowable payroll costs do not include:
- Salary and wages paid to an employee in excess of $100,000 computed on an annualized basis;
- Wages paid to employees under the Expanded Family Medical Leave Act and Emergency Paid Sick Leave Acts (both contained within the Families First Coronavirus Response Act (FFCRA)) for which the employer receives the credits provided by the FFCRA;
- The employer’s share of FICA and Medicare taxes; and
- Payroll costs related to employees whose principal place of residence is not in the U.S.
Mortgage and rent payments include such obligations that were in existence on or before February 15, 2020. This includes obligations with respect to both real property (e.g., your office or church building) and personal property (e.g., a company vehicle or equipment such as a copier owned by your organization).
Utility payments include payments for electricity, gas, water, transportation, telephone, or Internet access for which service began before February 15, 2020. It is not clear what is meant by “transportation.” It is possible this would cover the cost of operating a church or nonprofit-owned van or bus, but without further guidance, that may be an aggressive position. In addition, it is not clear whether Internet access includes Internet access installed in a staff member’s home. However, given current shelter-in-place and stay-at-home orders that require employees to work from home, this may be allowable.
Caution: For forgiveness to occur, the CARES Act states that the borrower must have incurred and paid the qualifying expenses during the eight weeks following receipt of the loan proceeds. The SBA informal guidance indicates that the borrower must pay the qualifying expenses for inclusion in the loan forgiveness. However, the SBA has not addressed how the term “incurred” is to be interpreted in this context. For example, if a borrower receives the loan proceeds on April 14 (i.e., the starting date for the eight-week period) and pays its usual semi-monthly payroll on April 15, is the borrower permitted to include the full amount of the April 15 payroll cost in its loan forgiveness amount, even though 13 of the days in the pay period occurred before commencement of the eight-week period?
Similarly, if a borrower who pays semi-monthly received its PPP loan proceeds on April 16, its eight-week period would end on June 10, 2020, five days before it paid its June 15, 2020 payroll Thus it would only have three pay periods during the eight-week period, even though the 2.5 factor used in computation for the maximum loan amount clearly contemplated covering payroll for two full months.
How to Prepare Your Documentation to Obtain Loan Forgiveness
Start planning now for the documentation you’ll need to provide to your lender. It’s important to note that forgiveness is prohibited if a borrower fails to comply with these documentation requirements.
You will need to submit an application for loan forgiveness that includes:
- Documentation verifying the number of full-time equivalent (FTE) employees on your payroll, hours worked by part-time employees (to facilitate the FTE computation), and rates of pay during both the eight-week period and the prior year measurement periods discussed in the section below regarding the headcount reduction factor. This documentation may include payroll tax filings filed with the IRS (e.g., IRS Form 941) and income, payroll, and unemployment insurance filings filed with state authorities. However, those documents may or may not include detail to the employee level. So be prepared to supplement this information with reports from your payroll processor that provide detail to the individual employee level.
- Documentation, such as invoices, canceled checks, payment receipts, and account statements or transcripts showing mortgage payments, rent payments, and utility payments.
- A mortgage statement or transcript from your lender verifying the amount of interest paid with each mortgage payment.
- A certification by an officer of your organization as to the truthfulness of the information submitted and certifying that the loan proceeds were used to retain employees; make mortgage interest, rent, or utility payments; or used for some combination of these purposes. This officer is often your CEO or CFO, but may be your board chair, board treasurer, board secretary, or, in the case of a church, your senior or executive pastor. Substantial penalties may apply if the signer knowingly makes a false statement.
- Any other documentation the SBA Administrator determines is necessary.
Know the Factors That Will Cause the Loan to Be Only Partially Forgiven
There are five principal factors that will result in less than 100% loan forgiveness.
First, if a PPP loan borrower obtained an Economic Injury Disaster Loan (EIDL) advance, then that amount must be subtracted from the loan forgiveness amount.
Example: Assume your organization borrowed $150,000, had qualifying expenses totaling $150,000, and also received an EIDL advance of $10,000. In this case, the amount forgiven will be $150,000 less the EIDL advance of $10,000, or $140,000.
This will leave your organization with a $10,000 outstanding loan balance to be repaid at 1% interest over the two-year period that began on the date of origination. The first payment will be due six months after the date of origination.
Second, the SBA interim rule announced on April 2, 2020 requires that at least 75% of the loan proceeds be used on payroll costs. These costs include:
- Salary and wages;
- Payments for group health insurance, including insurance premiums;
- Employer retirement contributions; and
- Taxes assessed on payroll by state and local authorities.
If your organization fails to meet this 75% threshold, then you will be required to repay that portion of the loan that caused you to not meet the threshold.
Example: Assume your PPP loan amount is $100,000. This means that you will need to expend at least $75,000 on payroll costs to receive 100% loan forgiveness. If you only spend $70,000 on payroll costs, then you will need to figure out the amount which, when multiplied by 75%, gives you $70,000. This is determined by dividing your actual payroll costs by 75%.
So in this example, $70,000 ÷ 75% is $93,333.33. This means your loan forgiveness amount will be reduced by $6,666.67 ($100,000 – $93,333.33 = $6,666.67) and you will have an outstanding loan balance equal to this amount ($6,666.67).
Third, wages paid to an employee for Expanded Family Medical Leave Act paid leave or Emergency Paid Sick Leave for which your organization receives the allowable credit under the FFCRA are not includible in your payroll costs. While you may be aware of this possibility, the unknown is the rate at which employees will apply for these paid leave benefits during the eight-week measurement period. Note that if you excluded these wages when computing your payroll costs, you are not required to exclude them a second time.
The remaining two sources of a reduction in your loan forgiveness amount are: (1) the headcount reduction factor; and (2) the salary and wage reduction amount. These are complex computations that are described in detail below.
Computation of the headcount reduction factor
To compute the headcount reduction factor:
- Compute the average number of FTE employees per month employed during the eight-week period beginning on the loan origination date.
- Divide the result, at the borrower’s discretion, by either:
a. The average number of FTE employees per month employed by the borrower between February 15, 2019, and June 30, 2019; or
b. The average number of FTE employees per month employed by the borrower between January 1, 2020, and February 29, 2020.
If the employer is a seasonal employer, the denominator of the factor is the average number of FTE employees per month employed by the borrower between February 15, 2019, and June 30, 2019.
When the formula requires the employer to use the average number of FTE employees per month, the average is computed by adding the number of FTE employees paid on each payday during the month divided by the number of paydays during the month.
The SBA has not provided guidance for how to perform this computation for partial months, such as February 15 through February 29. While guidance is pending, an approach that is consistent with the statute is to add the number of FTE employees paid on each payday during the partial month and divide this sum by the number of paydays during the partial month.
To compute the average number of FTE employees, calculate the average number of FTE employees for each pay period that falls within a month.
Caution: The CARES Act does not describe how part-time employee hours are to be converted to FTE employee hours. The SBA could determine that borrowers must use the calculation provided for in the Affordable Care Act. Until the SBA gives additional guidance, a borrower will not know which standard applies.
If the SBA decides to use the Affordable Care Act computation for computing full-time equivalent employees (perhaps a conservative approach), a full-time employee is an employee who works an average of 30 hours per week or more during a calendar month or at least 130 hours during a calendar month.
To determine the full-time equivalency of employees working fewer than 30 hours per week:
- Compute the total of all hours of service performed by non-full-time employees during a calendar month, but excluding any hours above 120 worked by an individual employee; and
- Divide the resulting total by 120.
The total number of full-time employees for that pay period is then added to the full-time equivalent employees for that pay period to arrive at the total full-time equivalent headcount for the pay period.
An alternate method previously used by the SBA for FTE computations considers all employees working 30 or more hours per week as full-time. To compute the full-time equivalent for part-time employees, hours of employees working fewer than 30 hours per week are aggregated and divided by 40. The result of the full-time employees and the full-time equivalency computation are added together to determine the headcount.
It remains to be seen which standard will be adopted for PPP loan forgiveness purposes. We will provide updates as the SBA issues guidance. We encourage you to check the COVID-19 Resources section of our website frequently for the latest information.
Example: Let’s consider a simple example illustrating the headcount reduction factor. Assume that during the eight-week loan forgiveness measurement period you have 15 full-time employees and 20 part-time employees. After applying whichever method the SBA announces for converting part-time employees into FTEs, you determine your total headcount for the eight-week period is 27. This is the numerator of the headcount reduction factor.
To compute the denominator, you perform the same computation for converting part-time employees to FTEs for the period described above that will give you the best answer. If the employer elects to use the period February 15, 2019 to June 30, 2019, the employer must compute the average number of FTEs for each month or part of a month, then average the monthly FTEs to arrive at the average FTEs over the entire period. If the result is less than or equal to 27 combined full-time and part-time FTEs, then that is the number you will want to use because you will end up with no reduction in headcount. However, if comparison to that period does not produce a favorable result, you can choose the alternate period of January 1, 2020 to February 29, 2020. Note that it does not matter which of these computations you perform first and you are not required to compute both.
If we assume your lowest full-time and part-time FTE headcount in either the February 15, 2019 to June 30, 2019 period or the January 1, 2020 to February 29, 2020 period is 30 FTEs, then your headcount reduction factor will the (30 – 27) ÷ 30, or 3 ÷ 30, which results in a headcount reduction factor of 10%.
If your loan forgiveness amount before taking the headcount reduction factor into account is $100,000, then you will be required to reduce your loan forgiveness amount by 10% of $100,000, or $10,000. Your resulting loan forgiveness amount will then be $90,000.
Computation of the salary and wage reduction amount
To compute the salary and wage reduction factor:
- Determine which employees, if any, experienced a salary or wage reduction during the eight-week period beginning on the loan origination date that is in excess of 25% of the employee’s total salary or wages during the most recent full quarter of employment prior to the loan origination date. In making this determination, exclude any employee who received an amount of salary or wages during any pay period during 2019 which exceeded $100,000 at an annualized rate of pay.
- For each such employee, compute the amount by which the salary and wage reduction exceeds 25%.
- The sum of the amounts computed in the preceding step is the salary and wage reduction amount.
To illustrate the salary reduction amount computation, consider the table below.
|Q1 2020 Salary or Wage||Annualized Rate of Pay During 2019||2019 Annualized Rate of Pay Exceeds $100,000||Quarterly Rate of Pay During 8-week Period||Period Over Period Change in Rate of Pay||Actual Pay During 8-week Period||75% of Q1 2020 Pay for an 8-week Period||Salary and Wage Reduction Amount|
The computations in the table above assume weekly pay periods. However, until additional guidance is released, it is unclear how bi-weekly and semi-monthly pay periods will be accounted for the purpose of the salary and wage reduction amount computation.
As you can see from the table above:
- Employee 1’s 2019 compensation exceeded the $100,000 threshold and is therefore not included in the salary and wage reduction amount computation.
- Employee 2’s compensation is less than $100,000, but her compensation was only reduced by 15% (on a quarter-over-quarter basis) and, therefore, she is excluded from the salary and wage reduction amount computation.
- Employee 3’s compensation was reduced by 30% (on a quarter-over-quarter basis) and, therefore, he is included in the salary and wage reduction amount computation, but only to the extent his salary was reduced by more than 25% between the first quarter of 2020 and the eight-week measurement period.
As the table shows, Employee 3’s actual pay during the eight-week measurement period was $8,076.92. If we convert his first quarter 2020 compensation to a comparable eight-week compensation amount, the result is (($18,750 × 4) ÷ 52) × 8, or $11,538.46. Seventy-five percent of $11,538.46 is $8,653.85. The difference between 75% of Employee 1’s first quarter 2020 rate of pay and his compensation during the eight-week measurement period is $8,653.85 – $8,076.92, or $576.92.
If your loan forgiveness amount before taking the salary and wage reduction amount into account is $100,000, then your loan forgiveness amount will be $100,000.00 – $576.92, or $99,423.08.
The headcount reduction factor and salary and wage reduction amount operate independently of one another. Therefore, either may apply, neither may apply, or both may apply.
Exception to the application of the headcount reduction factor and salary and wage reduction amount
There is an important exception to the application of the headcount reduction factor and salary and wage reduction amount where an employer rehires employees or restores the salary and wages of affected employees.
The headcount reduction exception factor applies where — during the period beginning on February 15, 2020, and ending on April 26, 2020 (the date 30 days after enactment of the CARES Act) — there is a headcount reduction as compared to the FTE headcount on February 15, 2020 that is eliminated by no later than June 30, 2020.
Similarly, the salary and wage reduction amount exception applies where, during the period beginning on February 15, 2020, and ending on April 26, 2020, there is a salary and wage reduction for one or more employees as compared to February 15, 2020, which is eliminated by not later than June 30, 2020.
The two exceptions operate independently of one another. Therefore, an employer may qualify for either one or both exceptions, or neither.
Remember, the intent of the PPP loan is to retain employees and their general salary levels.
How Long Will It Take to Know If Your PPP Loan is Forgiven?
The CARES Act stipulates that a lender must issue a decision regarding loan forgiveness within 60 days of receiving the application for loan forgiveness. However, borrowers should be prepared for delays in the process. Loan applications were all submitted within a short period and it follows that loan forgiveness applications will similarly be submitted within a narrow time frame.
Loan Forgiveness and Unrelated Business Income Tax
You may be wondering if the amount forgiven is subject to unrelated business income tax. The CARES Act explicitly states that the forgiven amount is excludible from gross income, notwithstanding the forgiven amount being treated as the cancellation of indebtedness.
Available Loan Payment Deferment Options
The interim rule announced on April 2, 2020, by the SBA states that payments of loan principal, interest, and fees will be deferred for six months. During this deferral period, interest will accrue on the outstanding loan balance. However, if the principal is forgiven, interest accrued through the date of forgiveness will also be forgiven. At present, it is unclear what portion of the loan interest will be forgiven if the loan principal is partially forgiven.
For any portion of a loan that is not forgiven, it is carried forward with a two-year term at an interest rate of 1% after the initial six-month deferral period.
Bank Account Considerations
Are PPP loan proceeds required to be deposited into — and accounted from — a separate bank account?
There is nothing in the CARES Act or subsequent SBA guidance that requires this. However, some organizations may determine that depositing the PPP loan proceeds in a separate bank account and releasing them as they make qualifying expenditures may assist them in tracking qualifying expenditures and in ensuring any unexpended balance remains available for repayment.
And don’t miss our recorded webcast on this topic: A First Look at Paycheck Protection Program Loan Forgiveness
Ted serves as partner, tax counsel, and Professional Practice Leader – Tax. As a certified public accountant and tax counsel, Ted advises exempt organizations of all sizes on a wide range of issues. This includes consulting on tax and employee benefit related matters, representation before state and federal tax authorities, and assistance with firm audit or advisory engagements to formulate advice and counsel on important operating and tax issues. Ted also leads the firm’s tax preparation practice, including IRS Forms 990 and 990-T and related state forms.