CLARIFIED RULES FOR PAYROLL PROTECTION PROGRAM LOAN
The extended deadline for the application of a Payroll Protection Program (PPP) loan has passed, and the Small Business Administration (SBA) has now shifted its focus on clarifying the rules for loan forgiveness. Businesses looking to maximize the amount of their PPP loan to be forgiven should be aware of the most current PPP loan forgiveness guidelines.
When to Apply for Loan Forgiveness
A borrower may submit a loan forgiveness application anytime – even before the completion of the covered period, if the borrower has used all PPP the loan proceeds. The covered period is one of the following:
- 24 week period, beginning on the date the PPP loan funds were received
- 8 week period, if the PPP loan was received before June 5, 2020
Borrowers with bi-weekly or weekly payroll schedules may also elect to use an alternative covered period, beginning on the first day of the first pay period following the receipt of the PPP loan proceeds. This alternative covered period only applies to payroll costs.
For example: A borrower is using a 24 week alternative covered period, and it received its PPP loan on Monday, April 20th. The first day of its next pay period following the PPP loan disbursement date is Sunday, April 26th. The first day of the alternative covered period is April 26th, and the last day is Saturday, October 10th.
In no event can the covered period or alternative covered period extend beyond December 31, 2020.
Forgivable Payroll Cost
Payroll costs include all forms of cash compensation paid to non-owner employees including tips, commissions, bonuses and hazard pay. The forgivable cash compensation per employee is limited to $100,000 on an annualized basis, which makes the maximum amount of compensation that can be forgiven if a 24 week covered period is elected to be $46,154 per non-owner employee.
Healthcare benefits, retirement plan contributions, state, and local employer taxes assessed on non-owner employee compensation are also added to the forgivable payroll cost.
The forgivable amount of compensation paid to self-employed individuals, independent contractors, partners in a partnership or owner-shareholders of C and S corporations are generally limited to the lesser of either:
- $20,833 or 2.5 months of their 2019 compensation, if the 24 week covered period is used
- $15,385 or 8 weeks of their 2019 compensation, if the 8 week covered period is elected
C or S Corporation Shareholders with Less Than 5% Ownership
The SBA has clarified that employee shareholders with less than 5% ownership of a C or S corporation are not subject to the owner-employee compensation rule. This means that cash compensation of up to $46,154 paid by a corporation that elects to use a 24 week period to a shareholder-employee with less than 5% interest qualifies for forgiveness. There is no similar exception for partners in a partnership. Payments to any partner, regardless of ownership interest, will be subject to the owner compensation limit, which is the lesser of $20,833 or 2.5 months of the partner’s 2019 net earnings from self-employment.
What About Owner Healthcare Benefits & Retirement Contributions?
The amount of owner healthcare benefits and retirement contributions that can be added to the forgivable payroll costs will depend on the business type.
Sole proprietors, independent contractors and partners in partnerships are not allowed to add the cost of health care expenses or retirement contributions to the forgivable amount.
- The cost of healthcare benefits paid or incurred during the covered period can be added to the forgivable amount for shareholders, regardless of ownership interest.
- Retirement plan contributions for shareholders can be added to the forgivable amount, regardless of ownership interest – limited to 2.5 months of their 2019 retirement contribution amount.
- Shareholders who own or less than 2% interest can add to the forgivable amount the cost of healthcare benefits and retirement contributions paid or incurred during the covered period.
- Shareholders who own at least 2% interest are not allowed to include healthcare benefits in the forgivable amount. Healthcare benefits form part of the salary of shareholders who own at least 2% interest, so this cost is included in the $100,000 annualized owner compensation limit. Retirement plan contributions for shareholders who own at least 2% interest can be added to the forgivable amount – limited to 2.5 months of their 2019 retirement contribution amount.
Reduction of Loan Forgiveness Amount
A borrower is required to reduce its forgiveness amount if there is a reduction in the number of full time equivalent (FTE) employees or if the amount of salary or wages paid is reduced by more than 25% during the covered period or the alternative covered period. There are several safe harbors that will eliminate the required reduction of the forgivable amount:
- There is a reduction in FTE employees between February 15th and April 26th, but the number of FTE employees is restored by December 31, 2020. The FTE employee reduction is not required, due to an inability of a business during the covered period to rehire individuals who were employees on February 15th. The business must notify the state unemployment insurance office within 30 days of a rejected offer. The business should maintain adequate documentation to show that it is unable to hire similarly qualified employees for unfilled positions by December 31, 2020.
- The business fired employees for cause, or employees voluntarily resigned and/or voluntarily requested and received a reduction in hours.
- A salary or wage reduction is restored by December 31, 2020.
- The business was unable to operate between February 15th and the end of the covered period at the same level of business activity as before February 15th, due to requirements or guidelines issued by federal agencies related to COVID-19 between March 1 and December 31, 2020.
Forgivable non-payroll costs include eligible mortgage interest costs, rent or lease costs and utility costs – all of which must be covered by contracts in force before February 15, 2020. Non-payroll costs are also limited to 40% of the total loan forgiveness amount, including the following:
- Rent or lease payments relating to a sublease arrangement are not eligible for loan forgiveness. For example: A borrower rents an office building for $10,000 per month and subleases out a portion of the space to other businesses for $2,500 per month. Only $7,500 per month is eligible for loan forgiveness.
- Rent payments to a related party are eligible for loan forgiveness only if the related party is paying mortgage interest attributed to the space being occupied by the borrower during the covered period. Both the lease contract and the mortgage should have been in effect prior to February 15, 2020. This limitation applies to any common ownership interest between the borrower and the property owner, i.e., there is no common ownership interest threshold.
- Mortgage interest payments to a related party are not eligible for forgiveness. There is also no common ownership threshold. For example: Mortgage interest payment to a partner with 1% interest in the partnership is not eligible for forgiveness.
- Home office expenses qualify for loan forgiveness, but only to the extent they were deductible on 2019 tax filings, or the borrower’s expected 2020 tax filings for a new business.
Timing of Payments
Payroll costs that were incurred before the covered period but paid during the covered period or alternative covered period are eligible for loan forgiveness. Payroll costs that were incurred during the covered period or the alternative covered period and paid afterward are eligible for loan forgiveness, if paid by the next regular payroll after the covered period/alternative covered period.
Non-payroll costs incurred before the covered period but paid during the covered period are eligible for forgiveness. Non-payroll costs incurred during the covered period and paid by the next regular billing date that occurs after the covered period are also eligible for loan forgiveness.
How Does Loan Forgiveness Affect Income Tax?
The CARES Act specifically provides that the amount of the PPP loan forgiven will not be taxable.
The Internal Revenue Service has advised there is no deduction allowed for expenses paid from the PPP funds that are forgiven, as these payments are attributed to income that is exempt from tax. However, pending legislation proposes to restore these deductions for tax purposes.
We continue to monitor these rapidly changing rules and programs, including a proposed second round of PPP loans under new legislation – the Continuing Small Business Recovery and Paycheck Protection Act. We are here to help you navigate various COVID-19 pandemic relief programs available to your business. Please connect with us for guidance.