April 16, 2020
“The $349 billion authorized for Paycheck Protection Program loans has been exhausted, the Small Business Administration said today, and the SBA is no longer accepting applications for PPP loans. Loan applications received by banks but not yet submitted to SBA will not be able to be completed, and the agency will not maintain a queue for PPP applications once additional funds are authorized. Any loan applications that have received an SBA authorization number will receive an SBA guaranty.”
This was according to the ABA Banking Journal in an article published on April 16, 2020. The chances are that if you are a small business owner, you likely have heard about the Paycheck Protection Program (“PPP”) and may have already applied for it and/or have been approved for it. But, now what?
As an initial matter, congratulations if you have been approved! The application process proved to be thoroughly chaotic, with unprepared banks, a lack of guidance and clarity that constantly changed, and long wait times.
Once you are approved, according to the Treasury’s oft-updated Frequently Asked Questions for the PPP number 20:
“The lender must make the first disbursement of the loan no later than ten calendar days from the date of loan approval.”
So, if you are trying to determine when you will receive the funds, the answer is that you will receive at least some of the funds no later than ten calendar days from the date that the loan was approved. There is no further guidance as to how much must be disbursed and when. However, federal banking regulators and the Federal Reserve have both eased reserve requirements for the PPP loans and created facilities to get money to the banks to fund the PPP loans.
But, once you get the funds, what should you do to make sure that you use them for proper purposes and also maximize your loan forgiveness? Pending guidance, following are key things that you need to understand regarding permitted uses of funds, and also the loan forgiveness calculations.
The CARES Act lists the following “allowable uses” of the PPP loans:
Payroll costs, which are generally defined to include the following:
Gross wages to U.S. based employees (maxed at an annual salary equivalent of $100,000, or $1,923 per week)
Cash tips
Payment for vacation, parental, family, medical, or sick leave (but excluding those for which a credit is given under the Families First Coronavirus Response Act)
Allowance for dismissal or separation (i.e. severance pay)
Group health care benefit expenses, including insurance premiums
Retirement benefits
State or local taxes assessed on employee compensation (i.e. unemployment benefits)
If the business obtaining the PPP was a sole proprietorship, “payroll costs” includes net income of the owner (capped at $100,000/year).
New regulations from April 15th also indicate that general partner income subject to self-employment tax is also considered “payroll costs” (also capped at $100,000/year).
Costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums.
Payments of interest on any business mortgage obligation (not including prepayments, or payment of principal)
Rent
Utilities
Interest on any other debt obligations incurred before 2/15/2020
Don’t confuse this list above with a list of expenses that qualify for forgiveness! This is just the list of expenses that are “OK” to use the loan proceeds for. Some of these items listed above don’t qualify for loan forgiveness.
Loan forgiveness is based on your spending on “costs incurred and payments made” on the following list of items during the eight week period that begins on the day the loan is disbursed to you:
Payroll costs (see definition above)
Payment of interest on certain “covered mortgage obligations”, which are generally debt secured by a mortgage on real or personal property, and which was incurred prior to 2/15/2020. Prepayments or payments of principal don’t count for this.
Payment of certain rent (generally rent incurred under a lease agreement in force before 2/15/2020)
Payment of certain utilities (generally electric, gas, water, transportation, telephone, or internet access for which service began before 2/15/2020)
With this background set, below is a list of best practices to help ensure you stay compliant with SBA rules for usage of the loan funds. Please stay tuned for more guidance, and be in touch with your accounting and legal professionals. This article outlines our best advice as of today, but we expect the SBA to issue more regulations imminently. Important things for you to consider include:
Segregating the loan funds in a separate account and only moving money into your general accounts as the funds are spent on approved purposes. This way, you will be able to trace the funds directly rather than having co-mingled the funds and having to explain to your bank or your regulator how the funds were spent. This is especially important if there might be unusual transactions like purchases of equipment that the loan proceeds cannot be used for.
Consider issuing partial payroll payments to make sure that you have cash-basis documentation of these payments rather than an accrual basis. In FAQ 20, Treasury stated that “The eight-week period begins on the date the lender makes the first disbursement of the PPP loan to the borrower.” Because your payroll may not naturally match up with the eight-week period, consider making partial payroll payments to your employees to make sure that you can track which payments were incurred during the eight-week period. This is most important for bi-monthly or monthly payrolls, as payments on a weekly or bi-weekly basis may more naturally align with the eight week forgiveness period. Of course, you will want to make sure that this complies with local or state laws pertaining to the timeliness of paying your employees, as federal law requires only “prompt” payment.
Consider making partial payments for healthcare expenses to make sure that you have cash-basis documentation of these payments rather than accrual basis documentation. We highly doubt that your health insurer will object to you at least partially paying the premiums ahead of schedule, but communicate with your health insurance carrier and request a bill for the period in question.
If you had implemented pay cuts, hour reductions, or layoffs and are going to restore pay, hours, and employees to maximize loan forgiveness on a temporary basis (pending the economy’s coronavirus recovery), communicate this to employees. Let them know that you are doing this for eight weeks because you are participating in the PPP, and this will give them certainty for the next eight weeks.
Maintain the best documentation that you can to substantiate how you used the funds. Keep payroll registers, invoices, cancelled checks, and detailed accounting records of your expenditures made with the loan proceeds.
Remember that the SBA is requiring that 75% of loan proceeds be used for payroll costs, even though the law doesn’t explicitly require this. If it takes you longer than the eight week forgiveness period to incur your payroll costs, make sure you are keeping your usage of loan proceeds well documented.
It is very common for businesses to have related party leases or debt that might qualify under the terms of the CARES Act as written. While these related party rent and interest expenses may seem to qualify under the terms of the law, we expect additional clarity in future regulations on this point.
If you know that a portion of the loan will not be forgiven because you have done a calculation with your tax or accounting professional, then consider leaving those funds in the segregated account to facilitate future repayment.
It may be common sense - but make the most of employees that you have on the payroll during this eight week period. If your workload is light, consider deploying employees to make improvements in the business, clean your premises, repair and replace equipment, etc.
This is a crisis - treat it like one! If you take a PPP loan, consider holding off on any owner/executive pay increases at least for the next 6-12 months (or even consider some pay cuts to owners as this crisis continues), along with “tightening your belt” for anything that could be perceived as extravagant. One of the conditions of the PPP loan is “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient”. Respect the crisis and carefully consider your communication - the PPP program is not “free money”! This program is designed to help businesses pay their employees through turbulent times.
You also must understand that there are several factors that can reduce your loan forgiveness amount. Simplistically, the eligible costs outlined above that are paid in the eight weeks following loan disbursal get forgiven, but there are several “catches”:
Your loan forgiveness may be reduced by comparing your “average number of full-time equivalent employees per month” on your payroll during the 8 week forgiveness period with one of the two numbers (you can pick):
The average number of full-time equivalent (“FTE”) employees per month employed during the period beginning 2/15/2019, and ending 6/30/2019, OR
The average number of FTE employees per month employed during the period beginning 1/1/2020, and ending 2/29/2020.
You calculate the average number of employees by averaging the FTE employee count for each payroll falling into the applicable period. If for example you had payrolls during 2/15 - 6/30/2019 that averaged 15 FTE, and payrolls during 1/1 - 2/29/2020 that averaged 17 FTE, you would choose the lower number (15 FTE) for this calculation.
You then compare this base period (15 FTE) in this example, to your FTE based on payrolls in the eight week forgiveness period. If for example you only had 10 FTE during this forgiveness period, you would have a 33.33% reduction in your loan forgiveness (10 FTE vs. 15 FTE in base period).
Your loan forgiveness can also be reduced if you cut any individual employee’s pay more than 25% (apparently via pay rates or hours, more guidance expected). This pay decrease is calculated by comparing employee pay during the eight week forgiveness period to the most recent full quarter of that employee’s pay. This rule doesn’t apply to any employees who made more than an annualized $100,000 pay rate during any pay period in 2019. For example, if you had an employee making $1,000 per week in the first quarter of 2020, and you cut their pay to $500 per week during the period that includes the eight week forgiveness period. In this case, your loan forgiveness is apparently reduced by $250 per week (i.e. the pay reduction in excess of 25%).
In short, you may get hit twice for cutting headcount or pay during the loan forgiveness period. For example, if you cut your payroll from 10 employees totaling $10,000 per week of payroll to 5 employees totaling $5,000 a week of payroll, you will be forgoing $40,000 of forgiveness for the reduced payroll itself (eight weeks x $5,000), and your forgiveness will also get reduced another 50% for cutting your headcount!
There is a provision in the law called an “exemption for re-hires” that in short can allow you to ignore headcount reductions that happen between 2/15 - 4/26/2020, as long as you have eliminated this reduction in FTE employees by June 30, 2020. A similar rule applies if you cut wages during this period and restore them by June 30, 2020. There is also a proscribed “de minimis” rule that will be created for small head-count changes, but this rule has not yet been written by the SBA. If you choose to rely on this re-hire exemption - keep in mind that your loan forgiveness amount may be curtailed by having a lower headcount and corresponding payroll during the eight week period, and you are also counting on being able to get back to full staffing by June 30th - which may be problematic.
As an additional consideration, remember that payroll costs are generally deductible for income tax purposes, but the loan forgiveness is tax-free. You may have to pay some incremental employer FICA tax (7.65%) on additional wages, but the income tax benefits should more than offset this for most businesses.
In summary, remember the intent of the CARES Act, which is to keep employees at their full compensation for the eight weeks following the PPP loan, regardless of whether they are able to work or not. You can think about this as the federal government agreeing to pay unemployment benefits at full salary—up to $100,000 per annum—through employers. This way, when you are ready to open your doors—if you have shut them—you already have the employees on payroll and will call them back in rather than having to re-hire them. So, if an employee voluntarily leaves and it reduces your FTE headcount, consider replacing the employee to maximize loan forgiveness.
There is a HUGE amount of uncertainty as we publish this, and this article is not intended to be exhaustive - so please monitor future guidance as it comes out, and be in close contact with your accounting and legal professionals during this time. Once you receive your PPP loan, you only get one eight week forgiveness period - make sure you thoughtfully optimize it and keep meticulous documentation.
Comments