A Second Look at PPP Loan Forgiveness
Since it launched, the Paycheck Protection Program (PPP) has resulted in many questions. One of the biggest was how the loan forgiveness component of the program would work.
On May 15, 2020, the U.S. Treasury Department and the Small Business Administration (SBA) released the Paycheck Protection Program Loan Forgiveness Application and accompanying schedules and instructions. At that time, the SBA also announced that it would provide further regulations and guidance regarding the forgiveness application.
Further regulations came on May 22, 2020, when the Treasury Department and the SBA issued two interim final rules addressing PPP loan forgiveness. The first interim final rule specifically speaks to includible costs and various computations required by the CARES Act (the Loan Forgiveness IFR). The second interim final rule addresses the PPP Loan Forgiveness Application review process (the Review Process IFR). In addition to these two interim final rules, we expect the SBA to release additional explanatory FAQs regarding loan forgiveness.
For a detailed discussion of the PPP Loan Forgiveness Application and our first take on guidance found in the instructions to the application, see our First Look at Applying for PPP Loan Forgiveness. In this article, we will focus on new information found in the interim final rules and changes to our understanding resulting from the publication of these new interim final rules.
Loan Forgiveness Process Overview
The PPP Loan Forgiveness Application instructions provide limited information on the process of reviewing PPP Loan Forgiveness Applications. The Loan Forgiveness IFR makes it clear that not only are Loan Forgiveness Applications submitted to the lender servicing the loan at the time forgiveness is sought, but “[a]s a general matter, the lender will review the application and make a decision regarding loan forgiveness.” However, in the Review Process IFR the SBA reserves the right to review any PPP Loan Forgiveness Application.1
The SBA states that during its review of the PPP Loan Forgiveness Application, it will review PPP loan eligibility “based on the provisions of the CARES Act, the rules and guidance available at the time of the borrower’s PPP loan application, and the terms of the borrower’s loan application.” With respect to the terms of the borrower’s loan application, the SBA may review the application in light of:
- General SBA loan eligibility guidelines as modified by subsequent interim final rules (e.g., rules regarding nondiscrimination);
- Size standards and affiliation rules (e.g., application of affiliation rules to faith-based organizations, exclusion of college work-study recipients from eligibility headcount); and
- The information, certifications, and representations on the loan application.
If the SBA determines that a borrower was not an eligible borrower, then no portion of its loan will be forgiven.
In addition to the loan application, the SBA may review:
- The calculation of the loan amount;
- The use of the loan proceeds; and
- The computation of and entitlement to the loan forgiveness amount presented on the loan forgiveness application.
As stated in the PPP Loan Forgiveness Application instructions, the SBA may initiate a review at any time in its discretion for a period of up to six years from the date the loan is forgiven or repaid in full.
The lender will have 60 days from the receipt of a “complete application” to inform the SBA and the borrower of its determination regarding loan forgiveness. At that time, the lender must request the forgiveness amount from the SBA. The SBA will then have 90 days to remit the forgiveness amount plus accrued interest on the forgiveness amount to the lender.
The Review Process IFR provides that if a lender denies a borrower’s loan forgiveness application in any amount, it must notify the borrower and the SBA of its determination. It must also provide to the SBA:
- The reason for the denial;
- A copy of the PPP Loan Forgiveness Application;
- The PPP Schedule A; and
- The PPP Borrower Demographic Information Form (if submitted by the borrower).
A borrower has 30 days to request that the SBA review the lender’s decision.
The Review Process IFR further provides that if the SBA determines that there is an issue with loan eligibility, the loan amount, or the loan forgiveness amount, the borrower will have an opportunity to respond. An appeals process will be provided to appeal an SBA determination regarding loan eligibility, the loan amount, and the loan forgiveness amount.
Any portion of the loan that is not forgiven will be subject to repayment over the remaining two-year term of the loan, with payments commencing after the conclusion of the six-month loan deferral period.
Payroll Costs Incurred or Paid, or Both
The Loan Forgiveness IFR defines four key terms relating to payroll costs:
- Payroll costs are generally incurred on the day the employee’s pay is earned (i.e., on the day the employee worked). For employees who continue to be paid even though they are not performing work (e.g., because of a stay-at-home order), payroll costs are deemed incurred based on the work schedule established by the employer, which would generally follow the schedule the employee would have worked if he or she were able to perform work.
- Payroll costs are considered paid on the day that paychecks are distributed to employees or the employer or its agent originates an ACH credit transaction in favor of the employee.
- The Covered Period begins on the date of the first disbursement of the borrower’s PPP loan proceeds from the lender and runs for eight consecutive weeks.2
- The Alternative Payroll Covered Period begins on the first day of the first payroll cycle within the Covered Period and runs for eight consecutive weeks.
The Loan Forgiveness IFR makes it clear that “payroll costs paid or incurred during the eight consecutive week (56 days) covered period are eligible for forgiveness.” (Emphasis added.) In addition to the above statement, payroll costs incurred during the Covered Period, but paid on or before the next regular pay date after the conclusion of the Covered Period (or the Alternative Payroll Covered Period, if elected) are eligible for forgiveness.
Subject to any further guidance contained in the promised FAQs or any future interim final rules, this statement of the rule appears to remove any doubt that payroll costs relating to days worked prior to the commencement of the Covered Period are includible, even though such costs were not incurred during the Covered Period. In addition, payroll costs incurred up to the 56th day of the Covered Period are eligible for forgiveness, even though they are paid outside the Covered Period (or the Alternative Payroll Covered Period). The Loan Forgiveness IFR does not provide specific guidance for cases where an employer uses differing pay periods for hourly versus salaried employees or has pay periods that are offset from pay dates to accommodate the recording of hours worked by hourly workers.
Where payroll costs are both paid and incurred during the Covered Period or the Alternative Payroll Covered Period, they may only be included once in eligible payroll costs.
Example. Assume the following facts regarding Trinity Church’s payroll:
- Trinity utilizes a bi-weekly payroll schedule (i.e., every other week).
- Trinity’s Covered Period begins on Monday, June 1, 2020 and concludes on Sunday, July 26, 2020.
- The last day of Trinity’s payroll period that includes June 1 is Saturday, June 6, 2020. Employees are paid on this date or if the date falls on a weekend they are paid on the Friday preceding the weekend, which in this case is Friday, June 5, 2020.
- In each bi-weekly payroll, salaried employees are paid for days worked through the last day of the payroll period. However, due to the need to record hours worked for hourly employees in the payroll system, the cutoff date for recording and paying hourly employees is three business days prior to the payroll period end date, which in this case is Wednesday, June 3, 2020.
Based on the foregoing facts, the full amount of Trinity’s June 6 payroll is eligible for forgiveness because it was during the Covered Period. There is no requirement to adjust the eligible amount to account for days paid but not incurred during the Covered Period (i.e., days worked before June 1). Nor is there a requirement to adjust for the staggered days of pay incurred between salaried and hourly employees.
Example. Assume the same facts as the preceding example with the following additional information:
- Trinity’s June 7 – June 20, June 21 – July 4, and July 5 – July 18 payroll periods represent amounts fully incurred and paid during the Covered Period and, therefore, are fully eligible for forgiveness.
- Trinity’s July 19 – August 1 payroll period crosses the last day of Trinity’s Covered Period (July 26, 2020). This pay period includes pay incurred through July 26 for both hourly and salaried employees.
Based on these facts, to determine the portion of the August 1 payroll costs eligible for forgiveness, Trinity will need to compute the payroll costs incurred from July 19 – July 26 for both salaried and hourly employees that are included in the August 1 payroll. Only this portion of the August 1 payroll is eligible for forgiveness.
Alternative Payroll Covered Period
The Alternative Payroll Covered Period is only available for employers using bi-weekly or more frequent pay periods. In addition, if the Alternative Payroll Covered Period is selected, it must be used each time a reference to the Covered Period is made in connection with payroll costs.
Example (from the Loan Forgiveness IFR). Assume the following facts regarding Faith Church’s payroll:
- Faith utilizes a bi-weekly payroll schedule (i.e., every other week).
- Faith’s Covered Period begins on Monday, June 1, 2020 and concludes on Sunday, July 26, 2020.
- The first day of Faith’s first payroll period after June 1, 2020 is Sunday, June 7, 2020.
Based on these facts, Faith may choose to select an Alternative Payroll Covered Period that commences on Sunday, June 7, 2020 and concludes on Saturday, August 1, 2020. Payroll costs paid during the Alternative Payroll Covered Period are eligible for forgiveness. In addition, any payroll costs incurred during the Alternative Payroll Covered Period but not paid until the first regular payroll date after August 1, 2020 are eligible for forgiveness.
Example. Assume the same facts as above, but further assume that while the first bi-weekly payroll period begins on Sunday, June 7, 2020 and ends on Saturday, June 20, 2020, the actual pay date lags by three business days to Wednesday, June 24, 2020 to allow for the entry of hours into the payroll system. Following this through the Alternative Payroll Covered Period, this means the June 24, July 8, and July 22 pay dates will occur within the Alternative Payroll Covered Period.
However, the pay date for the pay period that begins on Sunday, July 19, 2020 and ends on Saturday, August 1, 2020 will not occur until Wednesday, August 5, 2020. Because all of the days represented by the August 5 pay date represent payroll costs incurred on or before August 1 and August 5 is the first regularly scheduled pay date after August 1 (the last day of the Alternative Payroll Covered Period), the full amount of payroll paid on August 5 is eligible for forgiveness. In this example, 56 days of payroll costs incurred are eligible for forgiveness, since the selection of the Alternative Payroll Covered Period did not result in the inclusion of any payroll costs paid during the Alternative Payroll Covered Period but incurred prior to the start of the Alternative Payroll Covered Period.
Bonuses and Hazard Pay
The Loan Forgiveness IFR clarifies that bonuses and hazard pay are eligible for forgiveness as a form of compensation similar to salary, wages, and commissions. This eligibility is capped at $100,000 on an annualized basis. This cap effectively means that the total of all eligible compensation (salary, wages, commission, bonuses, hazard pay, and other similar compensation) may not exceed $15,385 for the Covered Period or the Alternative Payroll Covered Period.
Compensation Paid to Furloughed or Laid-off Employees
Noting that the purpose of the Paycheck Protection Program is to “enable[e] borrowers to continue paying their employees even if those employees are not able to perform their day-to-day duties, whether due to lack of economic demand or public health considerations,” the Loan Forgiveness IFR clarifies that compensation paid to furloughed workers in the form of salary, wages, commissions, or similar compensation is eligible for loan forgiveness. This eligibility is subject to the $100,000 annualized earnings cap on eligible compensation.
Non-payroll costs (i.e., mortgage interest, rent, and utilities) are includible if they are:
- Paid during the Covered Period; or
- Incurred within the Covered Period and paid on or before the next regular billing date, even if the billing date is after the Covered Period.
Example (adapted from the Loan Forgiveness IFR). The Covered Period for Joyful Heart Ministries (JHM) begins on June 1, 2020 and ends on July 26, 2020. JHM receives its May electricity bill covering the period May 1 – May 31, 2020 on June 8 and pays it on June 10. JHM receives its June electricity bill covering the period June 1 – June 30, 2020 on July 9 and pays it on July 13. JHM receives its July electricity bill covering the period July 1 – July 31, 2020 on August 10 and pays it on August 14.
The full amount of the May and June electricity bills is eligible for loan forgiveness because these bills were paid during the Covered Period. In addition, the portion of the July bill covering the period of July 1 – July 26 is eligible for forgiveness because the July bill was paid on the next regular billing date in August.
Observation. The example above makes it clear that the simplified approach the SBA has chosen means that more than 56 days of electricity costs are includible in the forgiveness amount. In the example, a total of 87 days of electricity costs are includible.
In addition, the rule would allow the inclusion of non-payroll related costs incurred months earlier but paid during the Covered Period to be included in the forgiveness amount, subject only to the requirement that 75% of the forgiveness amount be related to payroll costs.
Mortgage interest is clearly stated to include “[i]nterest payments on any business mortgage obligation on real or personal property that was incurred before February 15, 2020 (but not on any prepayment or payment of principal.” There are two key takeaways from this quoted text.
First, the mortgage obligation must be a business mortgage obligation. This shouldn’t preclude an allocable share of interest related to a bona fide home office, but it does emphasize that there must be a connection to a trade or business, or in the case of a church or nonprofit, a connection to its ministry or exempt activity. Further, there is no requirement that the real property or equipment currently be in use, but the mortgage obligation must qualify as a “business mortgage obligation.” This would appear to disallow the inclusion of mortgage interest on property held for investment.
Second, while prior guidance referenced both real and personal property, it did not do so with the clarity found in the Loan Forgiveness IFR. Thus, the rule includes mortgages on land and buildings and mortgages on equipment and other personal property, including automobiles and office equipment.
Rent is clearly stated to include “[p]ayments on business rent obligations on real or personal property under a lease that was in force before February 15, 2020.” As with mortgage interest, the rent obligation must be a “business rent obligation.” Similarly, the rule includes rent obligations on land, buildings, and equipment and other personal property, including automobiles and office equipment.
The Loan Forgiveness IFR provides no additional guidance on utility expenses.
The computation of full-time equivalent (FTE) employees has not changed from the explanation given in the PPP Loan Forgiveness Application. Full-time equivalency continues to be based on a 40-hour work week. It does not appear to be acceptable to base the FTE computation on time periods greater than one week using an appropriate multiple of 40 hours.
In reference to the simplified method of computing FTEs based on assigning a value of 1 to employees working 40 or more hours and a value of 0.5 to employees working fewer than 40 hours, the Loan Forgiveness IFR acknowledges that some employers may not track employee hours in sufficient detail to permit employers to perform an hours-based computation.
FTE Exceptions in the FTE Reduction Quotient Computation
The PPP Loan Forgiveness Application instructions identified four distinct circumstances in which an employer may include an employee who is no longer employed in the FTE calculations as though they were still employed. These four exceptions are:
- Extension of an offer to rehire a furloughed or laid-off employee or restore an employee’s reduced hours, which the employee declines;
- Termination of an employee for cause;
- The voluntary resignation of an employee; or
- An employee’s voluntary request for a reduction in hours.
With respect to offers to rehire a furloughed or laid-off employee, the Loan Forgiveness IFR details specific steps and documentation requirements to be eligible for this exception, including that:
- The employer made a good faith, written offer to rehire the employee or restore reduced hours;
- The offer was for the same salary or wages and the same number of hours as earned by the employee in the last pay period before he or she was furloughed, laid off, or had his or her hours reduced;
- The employee rejected the offer;
- The employer maintained records documenting the offer and the rejection; and
- The employer informed the applicable state unemployment insurance office of the employee’s rejection of the offer of employment within 30 days of the employee’s rejection of the offer.
This last requirement is new. The Loan Forgiveness IFR states that the method by which an employer can report the employee’s rejection of the offer of re-employment to the applicable state unemployment insurance office will be posted on the SBA’s website.
With respect to terminations for cause, voluntary resignations, or voluntary reductions in hours, employers are required to “maintain records demonstrating that each such employee was fired for cause, voluntarily resigned, or voluntarily requested a schedule reduction.”
FTE Reduction Quotient
The Loan Forgiveness IFR makes no changes to the computation of the FTE Reduction Quotient as described in the PPP Loan Forgiveness Application instructions.
Salary and Wage Reduction Amount
The Loan Forgiveness IFR clarifies that, as we suspected, the salary and wage reduction amount (SWRA) is triggered by a greater than 25% decrease in an employee’s rate of pay during the Covered Period when compared to the period beginning on January 1, 2020 and ending on March 31, 2020 (the most recent full calendar quarter before the Covered Period). For salaried employees, compare the weekly salary amount during the Covered Period to the weekly salary amount in the first quarter.
Example (from the Loan Forgiveness IFR). The CEO of Omega Children’s Services was paid a salary of $52,000 per year, or $1,000 per week, during the first calendar quarter of 2020. In response to a decrease in contributions resulting from the coronavirus pandemic, Omega’s board of directors voted to decrease the CEO’s compensation to a weekly rate of $700 per week ($36,400 per year). The CEO continued to work 40 hours per week.
The $300 per week decrease in weekly salary is a 30% decrease. Because it is greater than 25%, the SWRA is triggered. The SWRA is computed by subtracting from $300 the 25% allowable decrease, or $250. This results in a weekly excess reduction over the allowable reduction of $50 per week. This amount is then multiplied by eight weeks to arrive at an SWRA of $400.
This example is consistent with the approach illustrated in the example on page 11 of our First Look at Applying for PPP Loan Forgiveness article, with the exception that the salaried rate of pay is converted from an annual rate of pay to a weekly rate of pay before determining the extent of the decrease in the rate of pay.
Interaction of the FTE Reduction Quotient and the Salary and Wage Reduction Amount
The Loan Forgiveness IFR clarifies that employers will not be doubly penalized by salary and wage reductions that are attributable to an FTE reduction. To this end, the salary and wage reduction computation only applies to the portion of a decline in an employee’s wages that is not attributable to an FTE reduction.
Restoration of FTE Headcount and the Salary and Wage Reductions by June 30, 2020
The Loan Forgiveness IFR does not add anything new to our understanding of the restoration of FTE headcount or the restoration of salary and wage reductions by June 30, 2020.
As we noted above, we expect the SBA to release additional explanatory FAQs regarding loan forgiveness. We will provide updates as further information becomes available.
Please join us for a free webcast on this topic on June 1, 2020 at 1 p.m. EDT. Learn more and register here.
1Note that neither the Loan Forgiveness IFR nor the review process rule alter the good faith necessity safe harbor previously announced in FAQ 46 for PPP loans with an original principal balance of less than $2 million.
2The construction of this rule would imply that the important date is when the lender “disbursed” the funds and not the date on which the borrower actually received the funds (or had actual use of the funds).
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.