Now that some of the Paycheck Protection Program loans have been funded, with more coming based on new appropriations from Congress this week, questions have arisen related to the forgiveness of these loans. The CARES Act instructed the Small Business Administration to provide further guidance and regulations related to the forgiveness of PPP loans by April 26, 2020 and such SBA guidance and regulations may alter or supplement the following discussion. However, because forgiveness amounts both begin accruing and reducing as soon as funds have been received, many PPP loan recipients are in need of information in advance of that April 26, 2020 date.

What expenses are forgivable?

A PPP loan may be forgivable up to the full principal loan amount. It is important to note that only expenses incurred and paid during the eight-week period immediately following receipt of the PPP loan funds will be included in the forgiveness calculation. Forgivable expenses come in four general categories:

  1. Payroll costs. Payroll costs include:
  2. Salaries, wages, commissions and similar compensation, up to $100,000 annualized per employee (i.e. maximum wage forgivable per employee is $15,385 over the 8-week period);
  3. Payment for vacation, parental, family, medical or sick leave (but not including leave under the Families First Coronavirus Response Act);
  4. Allowance for dismissal or separation;
  5. Payment for group health care benefits, including insurance premiums;
  6. Payment of any retirement benefit; and
  7. Payment of state or local tax assessed on compensation of employees.
    **Note: payroll costs do not include the employer’s portion of federal payroll taxes, a portion of which (social security taxes) may be deferable under a separate provision of the CARES Act**
  8. Payment of Mortgage Interest. This expense must be for a business debt. This applies to real and personal property and must be based on a debt obligation that arose before February 15, 2020.
  9. Payment of Rent. The lease must have been in place prior to February 15, 2020. This applies to the lease of both real and personal property.
  10. Payment of Utility Expenses. This includes electricity, gas, water, transportation, telephone or internet access which was in service began before February 15, 2020.

How must the funds be used to qualify for maximum forgiveness?

To qualify for maximum forgiveness, 75% of the expenditures must be for payroll costs during the 8-week period. The current guidance is unclear, but it does appear that employers who spend less than 75% on payroll costs will have their maximum loan forgiveness reduced proportionally. Businesses should consider reasonable efforts to ensure that payroll costs equal or exceed this 75% threshold. A business struggling to reach the 75% threshold should consider options to make payments under the non-salary/wage items listed above (but still under payroll costs), including retirement plans and group health premiums. Non-salary/wage payroll costs are not subject to the $100,000 annualized compensation cap.

The remaining 25% then may be used for the mortgage interest, rent and utility expenses.

Can qualifying expenses be prepaid during the eight weeks after PPP funding is received?

Some businesses are struggling to find qualifying expenses to achieve maximum forgiveness. With additional guidance from the SBA, it may be possible that expenses may be prepaid during the 8-week period and then included in the forgiveness calculation. This is a source of uncertainty at the moment. Therefore, we recommend that any business contemplating prepaying any expenses await guidance on this issue from the SBA. That guidance should be coming soon.

How might the maximum loan forgiveness amount be reduced?

The maximum amount of forgiveness under the PPP can be reduced under the two following circumstances (in addition to failing to use 75% of the funds for payroll costs, discussed above):

  • Reduction in Salary. Forgivable amounts may be reduced if salary levels are reduced during the 8-week period following receipt of loan funds. The reduction in salary provisions applies for all employees whose annual salary was less than $100,000 on an annualized basis in 2019. If such an employee’s salary is reduced by more than 25% during the 8-week loan period as compared to that employee’s salary in the immediately preceding quarter (first quarter 2020 in this case), the maximum loan forgiveness amount will be reduced on a dollar-for-dollar basis for every dollar the payable salary during the 8-week period was reduced by more than 25%. The salary reduction is on a per specific employee basis and is not based on the business’s overall payroll levels. The SBA is expected to issue further guidance on the exact calculation of this reduction.

There will be no reduction in the forgivable amount if any salary reduction occurring between February 15, 2020 and April 26, 2020 is eliminated and the employee is returned to his or her previous salary no later than June 30, 2020.

  • Reduction in Employment Levels. One of the main goals of the Paycheck Protection Program is to encourage business owners to maintain their full-time employee levels. Accordingly, forgivable amounts may be reduced if a business has reduced its number of full-time equivalent employees (“FTEs”). To determine if the forgivable amount will be reduced, a business’s average number of FTEs during the 8-weeks after loan funding is compared to a base period. The base period is either February 15, 2019 through June 30, 2019 or January 1, 2020 through February 29, 2020, whichever period had lower average number of FTEs for the business (note, however, that seasonal business must use the former time period).

If the number of FTEs during the 8-week period is lower than the base period, then the forgivable amount will be reduced in proportion to such reduction. As an example, if a business had a total of $500,000 forgivable expenses during the 8-weeks after loan funding and had an average of 30 FTEs during the 8-week period but had an average of 50 FTEs during the applicable base period, the maximum forgivable amount would be $300,000 ($500,000 * (30/50)). The remaining $200,000 would have to be repaid by the business. Such amount would have a two-year maturity and would accrue interest at 1% per annum.

However, like salary reduction above, there will be no reduction in the forgivable amount if any reduction in FTEs occurring between February 15, 2020 and April 26, 2020, is eliminated by June 30, 2020. In other words, if the same number of FTEs terminated during this period are re-hired before June 30, 2020, the temporary reduction in workforce will not affect loan forgiveness. Note that it is not necessary for the business to re-hire the same employees or to re-hire for the same position. It is only total headcount that is important.

There are some unanswered questions regarding the impact of employee reduction on loan forgiveness. Foremost is whether loan forgiveness will be decreased if employee reduction was not the result of economic hardship caused by COVID-19, such as retirements or terminations due to poor performance. The language of the CARES Act makes no distinction between reduction in headcount for COVID-19 reasons and reduction for reasons unrelated to COVID-19. Like many of the other topics discussed above, we are awaiting further guidance from the SBA on this topic.

What documentation will be required to substantiate forgiveness amounts?

It is expected that the yet to be issued SBA guidance will identify specific documentation that will be required to substantiate the amount of loan forgiveness. Borrowers will want to have as much documentation as reasonable to show that the PPP funds were spent on forgivable expenses and that payroll and employees were maintained so as to avoid reduction of the forgivable amounts. Items that will assist in showing payment of forgivable expenses include payroll tax-filings (IRS Form 941), cancelled checks, and payment receipts. If feasible, a business may consider opening a separate bank account and placing all PPP funds in that account and then making the PPP authorized payments through such account. This is not required, but may be helpful in tracking payment of forgivable expenses. In any event, businesses are encouraged to be proactive in tracking their PPP spending and compiling as much supporting documentation as they can during the 8-week period.

Can AWD LAW help me?

AWD LAW is here to answer your questions. This summary is intended to serve as general information for interested persons, but it is not legal advice for any specific situation. AWD LAW attorneys are available to answer fact-specific questions for our clients. Our number is (928) 774-1478.

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