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Paycheck Protection Program Phase II: Loan Forgiveness

Paycheck Protection Program Phase II: Loan Forgiveness

Terms to watch for this blog post: PPP, 75/25 Rule, Qualified Expenses, Covered Period, FTEE

On March 27, the federal government allocated $349 billion in forgivable loans to small businesses under the Paycheck Protection Program (PPP)(PL 116-136 §1102), which is part of the Coronavirus Aid, Relief, and Economic Stability Act (CARES)(PL 116-136). Unfortunately, it was depleted in less than a week and had to “recharged” with additional funds later in April.

Now that disbursement of the funds has begun, borrowers are shifting their focus (and their phone calls to us) on how to spend the money in the hopes of not having to pay it back.

What is Considered a Proper Use of PPP Funds?

The government’s concept was to keep businesses open and employees paid. Businesses should be expected to use the borrowed funds quickly for operational costs and more importantly, for payroll during this pandemic crisis. These funds are not to be used as an emergency “cushion.” The law states that the borrower certifies in good faith that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant” and loan proceeds “will be used to retain workers and maintain payroll.”

Qualified Expenses:  Under the CARES Act (PL 116-136 §1102(F), PPP loan proceeds can be used for:

  1. “Normal” purposes most SBA 7(a) loans provide, such as working capital
  2. Payroll costs* (discussed in more detail later)
  3. Costs related to continuation of group health care benefits during periods of paid sick, medical, or family leave, as well as insurance premiums
  4. Mortgage interest payments
  5. Rent payments
  6. Utility payments
  7. Interest payments on existing debts that were in effect before February 15, 2020
  8. Refinancing an SBA Economic Injury Disaster Loan (EIDL) made between January 31, 2020, and April 3, 2020

paycheck protection program payroll

*SBA has declared in one of its Interim Final Rules that 75% of the PPP loan proceeds must be spent on payroll costs. This is being commonly referred to as the 75/25 rule.

If a borrower uses PPP funds for unauthorized purposes, the SBA will require the borrower to repay those amounts. If a borrower knowingly uses the funds for unauthorized purposes, the borrower could be accused of fraud, be subject to fines, penalties, and potential prosecution. The SBA can come after the borrower, the borrower’s shareholders, members, or partner(s) for the unauthorized use.

Loan Forgiveness (PL 116-136 §1106)

I mentioned earlier that the purpose of the PPP program is to quickly get money into the hands of small businesses and their employees. The PPP program provides an opportunity for complete forgiveness of the loan.

Those portions of the loan that are not spent quickly enough or for the right purposes must be repaid over two years.

Businesses may be eligible for loan forgiveness when PPP loan proceeds are spent on the types of expenses listed previously within the 8-week period after the loan is obtained (called the “Covered Period”) and at least 75% (the 75/25 Rule mentioned earlier) of qualified expenses were payroll costs.

The forgiven amount cannot exceed the principal amount of the PPP loan. (PL 116-136 §1106(d)(1)).

Payroll Costs. The CARES Act treats payroll costs as qualified expenses. (PL 116-136 §1106(b)(1)). Also see SBA guidance provided under Interim Rule 4.14.20.


Salary, wages, commissions, or similar compensation (up to an annualized $100,000, which equals a maximum of $15,385 per individual for the 8-week covered period), but not qualified sick and family wages for which a credit was allowed under §§7001 and 7003 of the Families First Coronavirus Response Act (FFCRA).

  1. Cash tips or equivalent
  2. Vacation, parental, family medical, or sick leave (excluding payments for emergency paid sick leave or expanded family and medical leaves)
  3. Separation or dismissal (severance) pay
  4. Group health insurance premiums (in addition to the wages)
  5. Retirement benefits (in addition to the wages)
  6. State or local payroll tax (in addition to the wages). Note that federal payroll taxes are not included.  Unemployment taxes would fall into the category of state or local taxes as well.

What About Employee Bonuses and Raises? We don’t have any definitive guidance as of today, so keep a watch out for more guidance. Based on everything we read, the business will likely have to justify that any bonuses and raises are, in fact, necessary to support ongoing operations of the business (remember the certification earlier?) And it’s also worth noting the $100,000 limitation on payroll per employee.

What About Sole Proprietors? Guidance provided indicates that owners use a “look-back” at the 2019 line 31 (net profit) of Schedule C or line 34 (net profit) of a Schedule F. Take 8/52 of that figure and it will give you the maximum a sole proprietor could use as their own “payroll” during the 8-week covered period (again, not to exceed $100,000 annualized or $15,385 as mentioned above). We are still waiting for additional guidance as to the ability of sole proprietors to add their own self-employed health insurance premiums or estimated state tax payments to this result. SBA Interim Rule 4.14.20 right now appears to say “no.”

What About Company Workforce Reductions? Remember that the CARES Act is designed to keep payroll flowing and businesses open.

The PPP compares the average number of FTEEs** that the borrower has each month during the 8-weeks after funds are distributed to the average number of monthly FTEEs the borrower employed during one of two base periods.

The borrower may choose either

  1. The period from February 15, 2019, to June 30, 2019, or
  2. The period from January 1, 2020, until February 29, 2020.

**FTEEs is not defined by either IRS or SBA. Prudence would dictate using 40 hours as the definition of “full time.” Therefore, if your client has 2 part-time employees working 20 hours each, that should result in 1 FTEE.  

The borrower should compare the number of FTEEs it had during both these periods and choose the period with the lower number of FTEEs. Note that the PPP looks at numbers of FTEEs, not specific employees. The goal in satisfying the 75/25 Rule is to bring the number of employees paid back to base period levels as soon as possible.

What About Rehiring Employees? To the extent that all or part of the reduction in FTEEs occurred between February 15, 2020, and April 26, 2020, and the borrower brings the number of FTEEs back to the level it had before February 15, 2020 by June 30, 2020, then the amount of loan forgiveness won’t consider any layoffs that occurred between February 16 and April 26, 2020. (–Fact-Sheet.pdf)

What About Businesses Who Face Having to Reduce Salaries but not the Number of Employees? (PL 116-136 §1106(d)(3)). Watch out that employers don’t reduce wages more than 25% during that 8-week covered period after receiving the loan. Forgiveness is reduced by the amount of any reduction in total salary or wages of any employee who earned less than $100,000 in 2019 during the 8 weeks after loan proceed disbursement that is in excess of 25% of the total salary or wages of the employee during the most recent

Paycheck Protection Program 75 25

quarter that the employee was employed before the date the loan proceeds were disbursed. This is different

from the FTEE discussion earlier in that this reduction does look at individual employees for whom the borrower has reduced pay.

We’ve Covered The 75% Part, Now How About the 25% Part of Expenses?

First item to consider: Would the expenses incurred be considered ordinary and necessary expenses on Schedule C or F?

Second item to consider: Did these expenses (or debts) exist prior to February 15, 2020? (PL 116-136 §1106(b)(3))

  1. Mortgage Interest (PL 1163-136 §§1106(a)(2) and (b)(2).
    Any interest on indebtedness incurred in the ordinary course of business before February 15, 2020 that is a mortgage on real or personal property is a qualified expense if you would deduct the interest on the Schedule C or Schedule F (not Schedule A) as principal residence indebtedness. This begs the question- What did the taxpayer use the borrowed funds for? Principal payments are not qualified expenses.
  2. Rent Payments. (PL 116-136 §1106(b(3))
    These payments are defined under the Act as payments of rent under a lease agreement in force before February 15, 2020. (I highlighted lease agreement because I’m concerned many of our self-rental arrangements don’t have written lease agreements in place—you will want to get that resolved quickly).  We have no definitive guidance if qualified expenses would include past due rent or if a taxpayer could prepay rent and have those payments be considered as qualified for forgiveness.
  3. Utilities. (PL 116-136 §1106(b)(4))
    Utilities include electricity, gas, water, telephone, or Internet access for which service began before February 15, 2020. These are qualified expenses for loan forgiveness.

There’s another issue with this section. IRS recently released Notice 2020-32. In that release, the IRS basically took the position that any ordinary and necessary business expenses paid out of PPP proceeds and that end up being forgiven as qualified expenses may not also be deducted as business expenses on a 2020 return. While that concept likely makes sense to us, as of May 5, a proposal is gaining traction in Congress to in fact allow a tax deduction for those expenses. This Bill has bipartisan support (imagine that) and is being spearheaded by Sen Chuck Grassly (R) and House Member Richard Neal (D).

When and What to Submit to Obtain Forgiveness. (PL 116-136 §1106(e) and (g)). A borrower must submit to the lender documentation deemed necessary to certify amounts eligible for loan forgiveness. I can’t stress this point enough—this info goes to the LENDER and not to US. I’m willing to bet there will be no uniformity as to what lenders demand and in what format they expect the documentation to be provided in order to certify the expenses for loan forgiveness. Lenders are to issue their decision within 60 days of the loan forgiveness application.

That’s a great deal to digest in one blog. Be aware that future guidance could change any and all of the information I just provided.

For a frame of reference, all I can say is that this situation is like the dilemma faced by Scotty from the most recent Star Trek: “The notion of transwarp beaming is like trying to hit a bullet with a smaller bullet, whilst wearing a blindfold, riding a horse.”

Montgomery Scott, 2258 (Star Trek)

Live long and prosper…

by Tom O’Saben, EA

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