According to the Small Business Association (SBA), as of May 11, 2020, more than 54,000 PPP loans had been made to Oregon small businesses totaling more than 7 billion dollars in disbursed funds. Once received, businesses had eight weeks to spend the funds on “payroll costs”, interest on mortgages, rent, and utilities. In order for the loan to be forgiven, the funds needed be spent on the required categories, businesses need to retain their employee levels, and not reduce salaries more than 25% for each covered employee. It appeared relatively straight forward – retain employees, spend the money as directed, and all is forgiven. Not so fast – the CARES Act provided little guidance on specifics and the SBA was tasked with providing ongoing guidance while the funds continue to be disbursed and expended. As of this writing, Congress is reviewing the requisite eight-week period as well as the re-hiring requirements and is considering extensions for both. Spending the funds on payroll during this narrow period and rehiring employees has proven difficult for many businesses. We will provide further updates as developments occur.
Prior to providing the current guidance on loan forgiveness, the SBA issued guidance on the PPP program generally. Much of this guidance came after businesses had applied for, received their PPP loan, and began to spend it as instructed. These businesses were now “borrowers” and were receiving guidance on spending requirements and sanctions for failure to adhere to them. Specifically, the SBA issued an interim final rule requiring that at least 75% of the loan proceeds be spent on payroll costs and no more than 25% of the proceeds be applied to rent, utilities, and interest. This percentage break down worked for some Borrowers, but not for others and businesses were forced to re-allocate spending within the critical 8 week period. The SBA in consultation with the Department of Treasury provides periodic answers to frequently asked questions (FAQs). In response to FAQ number 46, the SBA addressed the PPP good faith certification required of Borrowers when application for PPP funds is made that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant”. In its answer, the SBA determined that a safe harbor will apply. The safe harbor provides: Any Borrower that, together with its affiliates, received a PPP loan in the principal amount of 2 million or less, will be deemed to have made the required certification in good faith. The SBA will utilize its resources to audit the larger loans in principal amounts of 2 million and above.
The IRS also got into the act by determining that permitted expenses paid by businesses from the PPP loan that are ordinarily deductible would not be deductible expenses come tax time. Despite pressure to do so, the IRS/Treasury has not changed its mind: any amount of a PPP spent on otherwise deductible expenses are NOT deductible. There is a pending bill (S3596) that would overturn this if passed.
Loan forgiveness is the central component of the PPP program. Although the terms of the loans are favorable standing alone: no personal guarantees, a six month forbearance, repayment over two years at 1% interest – it was the opportunity to have all or a large portion of loan forgiven that induced many businesses to apply for the funds in the first place. The first loans began to be disbursed in the beginning of April and it was not until May 15 that the SBA provided its first formal guidance on PPP loan forgiveness – in the form of a PPP Loan Forgiveness Application.
The Application contains the following components: a PPP forgiveness calculation form; a PPP Schedule A and Worksheet; and an optional PPP demographic information form. In addition to the worksheets, the instructions provide definitions for terms critical to calculating the forgiveness amount. For a complete list of the defined terms review the link provided above, but the following terms are worth highlighting.
Forgivable Payroll and Nonpayroll Expenses
- Covered Period. The eight-week (56-day) period beginning from the date of disbursement is the Covered Period for considering forgiveness. For administrative convenience, there is also an “Alternative Payroll Covered Period” which allows the covered period to begin “on the first day of their first pay period following their PPP Loan Disbursement Date”. This is to accommodate borrowers that utilize a bi-weekly or more frequent payroll schedule
- Eligible Payroll Costs. Subject to Congressional revision, Borrowers are eligible for forgiveness for payroll costs paid and incurred during the eight week period. Borrower’s payment to employees occurs on the day payment is distributed to employees or Borrower originates an ACH transaction. Payroll costs accrue on the day employee’s pay is earned. Payroll costs incurred but not paid during the eight week period are forgivable if on or before the next regular payroll date. The Application refers to the PPP Interim Final Rule of April 2, 2020 for a list of what qualifies as “payroll costs”.
- Eligible Nonpayroll Costs. These forgivable costs include: the interest on obligations for both real and personal property incurred prior to February 15, 2020; business rent or lease obligations for real or personal property in force before February 15, 2020; and utility payments defined as business payments for distribution of electricity, gas, water, transportation, telephone, or internet access which began prior to February 15, 2020. Eligible costs must be paid within the eight week period or incurred during the period and paid prior to the next billing date.
Forgiveness Related to Employee Retention and Salary/Hourly Wage Reduction
Even if a business is otherwise eligible for loan forgiveness based upon its permissible expenditures on payroll and nonpayroll costs, the amount of the PPP loan that may be forgiven is subject to two possible limitations related to (1) head count and (2) wage reductions. The Application addresses employee retention and salary reductions in the following manner:
- Average FTE. The Application resolves any uncertainty on what number of hours constitute a full-time equivalency. It is 40 hours. Borrowers must enter the average number of hours paid per week for each employee and divide that number by 40. Borrowers are capped at 1.0 per employee and have the option to assign a 1.0 for employees who work 40 hours or more per week and 0.5 for employees who work fewer. This calculation will be used to determine whether the borrower reduced its FTE during the covered period. Forgiveness will be impacted if the FTE during the covered period is less than the average during the Borrower’s chosen reference period (2/15/19 – 6/30/19 or 1/1/20 – 2/29/20). The Borrower is exempt from such reduction if the FTE Reduction Safe Harbor as defined below applies.
- Salary/Hourly Wage Reduction. The amount of forgiveness may be impacted if the Borrower reduced salary or wages of certain employees from the employee’s average pay levels between 1/1/20 and 3/31/20. The Application establishes a three step process to determine if the Borrower’s forgiveness amount will be reduce. Step 1 determines if the average pay was reduced by more than 25%; Step 2 determines if the Salary/Hourly Wage Reduction Safe Harbor (defined below) is met; and Step 3 Determines the actual Salary/Hourly Wage Reduction. This process must be completed for each employee.
- FTE Reduction Exceptions. The Application formalizes some of the previous guidance provided by the SBA related to Borrower’s attempts to re-hire laid off or furloughed employees. The Borrower is exempt if any of the following apply: (1) it made a good-faith, written offer to rehire an employee during the eight week period or alternate period, which was rejected by the employee; (2) any of the employees during the covered periods were terminated for cause; (3) voluntarily resigned; or (4) voluntarily requested and received a reduction in hours. These exemptions only apply if the positions were not re-filled.
- FTE Reduction Safe Harbor. Despite the calculations required above, the Borrower is exempt from the resulting reduction in forgiveness if it can satisfy both of the following conditions: (1) The reduction in FTE employee levels occurred between February 15, 2020 and April 26, 2020; and (2) the Borrower then restored its FTE employee levels by not later than June 30, 2020 to its FTE employee levels as of February 15, 2020.
- Salary/Hourly Wage Reduction Safe Harbor. Similar to the FTE Reduction Safe Harbor provision, the Borrower is exempt from a reduction in forgiveness if the employee’s average annual salary or hourly wage as of June 30, 2020 is equal to or greater than his or her salary or hourly wage as of February 15, 2020. This applies only to those covered employees whose salaries or hour wages were reduced more than 25% during the Covered Period or Alternative Covered Period as compared to their average compensation from January 1, 2020 to March 31, 2020.
PPP loan applications continue to be filed, approved, and funds disbursed. The second round of funding has not yet been exhausted. Despite real movement to extend the eight week Covered Period for expenditure, Borrower’s eight week Covered Periods are still being established. Unlike Borrowers that received the initial loans, businesses receiving loans now will benefit from the previous SBA guidance and specifically the instructions contained in the recent Forgiveness Application. Borrowers should anticipate further guidance and possible changes to the Covered Period.
There does not yet appear to be a firm deadline for filing the Application. More information is to come. However, based upon the Safe Harbor exemption deadline of June 30, 2020, it does not make sense to file the Application until after that date. The Application requires the Borrower to submit detailed payroll records and proof of existence of eligible expenses. Further, the Borrower must retain all relevant records, both submitted and not submitted for six years from the date the loan is forgiven or paid in full. For Borrowers with numerous employees the process will be cumbersome so those who have maintained complete payroll and banking records will be rewarded when undergoing the calculations required in the Application.
The PPP loan to grant process continues to evolve along with other governmental responses to the ongoing COVID-19 pandemic and if you have questions about this notice or any other issue currently facing your business during this ongoing crisis, we are here to help you. You can contact any of our Business Practice Group members at (503) 323-9000. Thank you, stay safe and together we will get through this.