The PPP Loan: “Absolution” May Be Yours, But There is a Price

May 26, 2020

Surprise

What were you doing on the afternoon of Friday, May 22, 2020? “Preparing” for the extended Memorial Day weekend, perhaps? “Leaving the office” early to get a jump on the holiday traffic?

Whatever you may have been doing, it was a time for “clarification” at the SBA, as the agency issued more “interim final” (temporary?) rules on the requirements for loan forgiveness under the Paycheck Protection Program (“PPP”).

The Promise of Forgiveness

Of course, you will recall that the PPP was enacted as part of the CARES Act to assist businesses and their employees through the economic downturn that resulted from the social-distancing measures adopted by the States to contain the spread of the COVID-19 virus. The PPP enlisted private lenders to make nonrecourse, unsecured loans to “small businesses” that were adversely affected by these measures, and directed the SBA to guarantee 100 percent of such loans.

What’s more, provided the borrower-business used the loan proceeds over an 8-consecutive-week “covered period” (56 days) for certain prescribed purposes (“covered costs”), the loan would be forgiven. As an added bonus, the borrower would not be required to include the amount of the loan forgiven as cancelation of indebtedness income for tax purposes. (There is some consensus in Congress to extend this period, at least for some industries.)

Covered Costs

By now, you should be able to recite from memory the covered expenses for which PPP loan proceeds must be used in order for the borrower to enjoy these favorable results.

At the top of the list is payroll costs, which consist of compensation to employees (residing in the U.S.) in the form of salary, wages, commissions, or similar compensation; cash tips or the equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate of such tips); payment for vacation, parental, family, medical, or sick leave; allowance for separation or dismissal; payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums, and retirement; and payment of state and local taxes assessed on compensation of employees.

Also included are certain “nonpayroll” costs, consisting of interest payments on any business mortgage obligation on real or personal property that was incurred before February 15, 2020 (but not any prepayment or payment of principal), payments on business rent obligations on real or personal property under a lease agreement in force before February 15, 2020, and business utility payments for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.

These eligible nonpayroll costs cannot exceed 25 percent of the loan forgiveness amount; in other words, at least 75 percent of the PPP loan proceeds must be used for payroll costs. (There is some consensus in Congress to relax this requirement.)

“Ask and You Shall Receive” – Not Quite

In order to receive loan forgiveness, a borrower must ask for it by completing and submitting the Loan Forgiveness Application to its lender after the expiration of the 8-week covered period. As a general matter, the lender will review the application and make a decision regarding the requested loan forgiveness within 60 days of having received a complete application.

If the lender determines that the borrower is entitled to forgiveness of some or all of the amount applied for, the lender must request payment from the SBA at the time the lender issues its decision to the SBA. The SBA will, subject to any SBA review of the loan or loan application, remit the appropriate forgiveness amount to the lender, plus any interest accrued through the date of payment, not later than 90 days after the lender issues its decision to the SBA.

If the SBA determines, in the course of its review, that the borrower was ineligible for the PPP loan, the loan will not be eligible for loan forgiveness.

If only a portion of the loan is forgiven, or if the forgiveness request is denied, any remaining balance due on the loan must be repaid by the borrower on or before the second anniversary of the loan.

Payroll Costs – Alternative Covered Period

In general, payroll costs paid or incurred during the covered period are eligible for forgiveness. Borrowers may seek forgiveness for payroll costs for the eight weeks beginning on either:

1. the date of disbursement of the borrower’s PPP loan proceeds from the lender (i.e., the start of the covered period); or
2. the first day of the first payroll cycle in the covered period (the “alternative payroll covered period”).

Payroll costs are considered paid on the day that paychecks are distributed or the borrower originates an ACH credit transaction. Payroll costs incurred during the borrower’s last pay period of the covered period or the alternative payroll covered period are eligible for forgiveness if paid on or before the next regular payroll date; otherwise, payroll costs must be paid during the covered period (or alternative payroll covered period) to be eligible for forgiveness.

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 are not performing work but who are still on the borrower’s payroll, payroll costs are incurred based on the schedule established by the borrower (typically, each day that the employee would have performed work).

According to the SBA, a borrower with a bi-weekly (or more frequent) payroll cycle may elect to use an alternative payroll covered period that begins on the first day of the first payroll cycle in the covered period and continues for the following eight weeks.

If payroll costs are incurred during this eight-week alternative payroll covered period, but paid after the end of the alternative payroll covered period, such payroll costs will be eligible for forgiveness if they are paid no later than the first regular payroll date thereafter.

Example: A borrower has a bi-weekly payroll schedule (every other week). The borrower’s eight-week covered period begins on June 1 and ends on July 26. The first day of the borrower’s first payroll cycle that starts in the covered period is June 7. The borrower may elect an alternative payroll covered period for payroll cost purposes that starts on June 7 and ends 55 days later (for a total of 56 days) on August 1. Payroll costs paid during this alternative payroll covered period are eligible for forgiveness. In addition, payroll costs incurred during this alternative payroll covered period are eligible for forgiveness as long as they are paid on or before the first regular payroll date occurring after August 1. Payroll costs that were both paid and incurred during the covered period (or alternative payroll covered period) may only be counted once.

Furloughed Employees

The SBA clarified that, if a borrower pays furloughed employees their salary, wages, or commissions during the 8-week covered period, those payments are eligible for forgiveness as long as they do not exceed an annual salary of $100,000, as prorated for the covered period. In other words, borrowers can 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 SBA also determined that, if an employee’s total compensation does not exceed $100,000 on an annualized basis, the employee’s hazard pay and bonuses will be eligible for loan forgiveness because they constitute a supplement to salary or wages, and are thus a similar form of compensation.

Owner-Employees

However, the SBA also provided that the above $100,000 cap on the amount of loan forgiveness also applies for owner-employees’ own payroll compensation. Specifically, the amount of loan forgiveness requested for owner-employees’ payroll compensation can be no more than the lesser of: (i) 15.38 percent of 2019 compensation paid to such individuals (8 weeks/52 weeks) or (ii) $15,385 per individual (8 weeks of payroll based on annualized compensation of $100,000).

Nonpayroll Costs

The SBA also explained when nonpayroll costs must be incurred and/or paid in order to be eligible for forgiveness. A nonpayroll cost, the agency stated, is eligible for forgiveness if it was:

1. paid during the covered period; or
2. incurred during the covered period and paid on or before the next regular billing date, even if the billing date is after the covered period.

Example: A borrower’s covered period begins on June 1 and ends on July 26. The borrower pays its May and June electricity bill during the covered period and pays its July electricity bill on August 10, which is the next regular billing date. The borrower may seek loan forgiveness for its May and June electricity bills, because they were paid during the covered period. In addition, the borrower may seek loan forgiveness for the portion of its July electricity bill through July 26 (the end of the covered period), because it was incurred during the covered period and paid on the next regular billing date.

Advance payments of interest on a covered mortgage obligation are not eligible for loan forgiveness because the PPP’s loan forgiveness provisions regarding mortgage obligations specifically exclude “prepayments.” Principal on mortgage obligations is not eligible for forgiveness under any circumstances.

Reduced Forgiveness

A borrower’s loan forgiveness amount may be reduced based on reductions in full-time equivalent (“FTE”) employees or in employee salary and wages during the covered period, subject to an important statutory exemption for borrowers who have rehired employees and restored salary and wage levels by June 30, 2020 (with limitations). (There is some consensus in Congress that this deadline should be moved to December 31, 2020.)

The SBA reminded us that it has adopted a regulatory exemption to the reduction rules for borrowers who have offered to rehire employees or to restore employee hours, even if the employees have not accepted. The agency also explained how these statutory forgiveness reduction formulas work.

A borrower’s loan forgiveness amount, it stated, will not be reduced if the borrower laid-off or reduced the hours of an employee, then offered (i) to rehire the same employee for the same salary and same number of hours, or (ii) to restore the reduction in hours, but (iii) the employee declined the offer.

In other words, employees whom the borrower offered to rehire are generally exempt from the PPP’s loan forgiveness reduction calculation. This exemption is also available if a borrower previously reduced the hours of an employee and offered to restore the employee’s hours at the same salary or wages. Specifically, in calculating the loan forgiveness amount, a borrower may exclude any reduction in FTE employee headcount that is attributable to an individual employee if the following requirements are satisfied (wait for the last one):

1. the borrower made a good faith, written offer to rehire such employee (or, if applicable, restore the reduced hours of such employee) during the covered period or the alternative payroll covered period;
2. the offer was for the same salary or wages and same number of hours as earned by such employee in the last pay period prior to the separation or reduction in hours;

iii. the offer was rejected by such employee;

1. the borrower has maintained records documenting the offer and its rejection; and
2. the borrower informed the applicable state unemployment insurance office of such employee’s rejected offer of reemployment within 30 days of the employee’s rejection of the offer.

In general, a reduction in FTE employees (see below) during the covered period or the alternative payroll covered period reduces the loan forgiveness amount by the same percentage as the percentage reduction in FTE employees.

The borrower must first select a reference period: (i) February 15, 2019 through June 30, 2019; (ii) January 1, 2020 through February 29, 2020; or (iii) in the case of a seasonal employer, either of the two preceding methods or a consecutive 12-week period between May 1, 2019 and September 15, 2019.

If the average number of FTE employees during the covered period or the alternative payroll covered period is less than during the reference period, the total eligible expenses available for forgiveness is reduced proportionally by the percentage reduction in FTE employees. For example, if a borrower had ten (10) FTE employees during the reference period and this declined to eight (8) FTE employees during the covered period, the percentage of FTE employees declined by 20 percent and, thus, only 80 percent of otherwise eligible expenses are available for forgiveness.

FTE

The SBA has determined that, for these purposes, a FTE employee means an employee who works 40 hours or more, on average, each week. The hours of employees who work less than 40 hours are calculated as proportions of a single FTE employee and aggregated (rather than the 30 hour standard it was reported to have considered using previously).

Borrowers seeking forgiveness must document their average number of FTE employees during the covered period (or the alternative payroll covered period) and their selected reference period. For purposes of this calculation, borrowers must divide the average number of hours paid for each employee per week by 40, capping this quotient at 1.0. For example, an employee who was paid 48 hours per week during the covered period would be considered to be an FTE employee of 1.0.

For employees who were paid for less than 40 hours per week, borrowers may choose to calculate the full-time equivalency in one of two ways. First, the borrower may calculate the average number of hours a part-time employee was paid per week during the covered period. For example, if an employee was paid for 30 hours per week on average during the covered period, the employee could be considered to be an FTE employee of 0.75. Similarly, if an employee was paid for ten hours per week on average during the covered period, the employee could be considered to be an FTE employee of 0.25. Second, for administrative convenience, borrowers may elect to use a full-time equivalency of 0.5 for each part-time employee.

Borrowers may select only one of these two methods, and must apply that method consistently to all of their part-time employees for the covered period or the alternative payroll covered period and the selected reference period. In either case, the borrower shall provide the aggregate total of FTE employees for both the selected reference period and the covered period or the alternative payroll covered period, by adding together all of the employee-level FTE employee calculations. The borrower must then divide the average FTE employees during the covered period or the alternative payroll covered period by the average FTE employees during the selected reference period, resulting in the reduction quotient.

Reduction in Salary

A reduction in an employee’s salary or wages in excess of 25 percent will generally result in a reduction in the loan forgiveness amount, unless an exception applies. Specifically, for each new employee in 2020 and each existing employee who was not paid more than the annualized equivalent of $100,000 in any pay period in 2019, the borrower must reduce the total forgiveness amount by the total dollar amount of the salary or wage reductions that are in excess of 25 percent of base salary or wages between January 1, 2020 and March 31, 2020 (the reference period), subject to exceptions for borrowers who restore reduced wages or salaries. This calculation is performed on a per employee basis, not in the aggregate.

Example: A borrower reduced a full-time employee’s weekly salary from $1,000 per week during the reference period to $700 per week during the covered period. The employee continued to work on a full-time basis during the covered period with an FTE of 1.0. In this case, the first $250 (25 percent of $1,000) is exempted from the reduction. Borrowers seeking forgiveness would list $400 as the salary/hourly wage reduction for that employee (the extra $50 weekly reduction multiplied by eight weeks).

Overlap of FTE & Salary Tests

The explained how borrowers seeking loan forgiveness should account for the reduction based on a reduction in the number of employees relative to the reduction relating to salary and wages.

To ensure that borrowers are not doubly penalized, the salary/wage reduction applies only to the portion of the decline in employee salary and wages that is not attributable to the FTE reduction.

The PPP does not address the intersection between the FTE employee reduction provision and the salary/wage reduction provision. To help ensure uniformity across all borrowers in applying the FTE reduction provision and the salary/wage reduction provision, the SBA determined that the salary/wage reduction applies only to the portion of the decline in employee salary and wages that is not attributable to the FTE reduction.

Example: An hourly wage employee had been working 40 hours per week during the borrower selected reference period (FTE employee of 1.0) and the borrower reduced the employee’s hours to 20 hours per week during the covered period (FTE employee of 0.5). There was no change to the employee’s hourly wage during the covered period. Because the hourly wage did not change, the reduction in the employee’s total wages is entirely attributable to the FTE employee reduction and the borrower is not required to conduct a salary/wage reduction calculation for that employee.

If a borrower restores reductions made to employee salaries and wages or FTE employees by not later than June 30, 2020, the borrower may avoid a reduction in its loan forgiveness amount.

The PPP provides that if certain employee salaries and wages were reduced between February 15, 2020 and April 26, 2020 (the safe harbor period), but the borrower eliminates those reductions by June 30, 2020 or earlier, the borrower is exempt from any reduction in loan forgiveness amount that would otherwise be required due to reductions in salaries and wages.

Similarly, if a borrower eliminates any reductions in FTE employees occurring during the safe harbor period by June 30, 2020 or earlier, the borrower is exempt from any reduction in loan forgiveness amount that would otherwise be required due to reductions in FTE employees.

The SBA explained that the PPP gives borrowers an opportunity to cure reductions in FTEs, salary/wage reductions in excess of 25 percent, or both. However, the agency added, this does not change or affect the requirement that at least 75 percent of the loan forgiveness amount must be attributable to payroll costs.

“Permitted” Reduction in FTE

Significantly, a borrower’s loan forgiveness amount will not be reduced if an employee is fired for cause, voluntarily resigns, or voluntarily requests a schedule reduction.

Thus, when an employee of the borrower is fired for cause, voluntarily resigns, or voluntarily requests a reduced schedule during the covered period or the alternative payroll covered period (FTE reduction event), the borrower may count such employee at the same full-time equivalency level before the FTE reduction event when calculating the employee reduction penalty.

Effective Date

The foregoing rules are effective immediately, but given the frequency with which the SBA is issuing and then amending its so-called “interim final” PPP rules, who knows?

The June 30 “cure deadline” is around the corner, yet many businesses have yet to spend any of their PPP loan. Both political parties – or at least many of their rank-and-file members – have agreed that the PPP needs to be amended (see the parentheticals, above, for example), but their leaders are in campaign mode, and the Senate is in recess.