We then moved onto forgiveness, wading through an extensive set of rules, again, scant on details or definitions of important terms. After more than 15 Interim “final” Rulings (“IFRs”) and a first draft of a forgiveness application, we had thought we finally got to the finish line with respect to how forgiveness worked. Then came the Paycheck Protection Program Flexibility Act of 2020., which upended many of the rules. If it felt like a roller coaster, that is because it was.
Even with all of these changes, the reality is that “most” of this story has now been told, many of the questions have ultimately been answered and now it is time to look to the future regarding Borrowers’ completion of their Covered Period (“CP”) and application for forgiveness.
This article has been written and re-written as the rules have evolved. This is what we know as of now:
The CARES Act lists four general categories of expenses that are forgivable. This means that your PPP loan is forgivable to the extent you spend the loan proceeds on expenses within these four categories, and you maintain the headcount and salaries of employees at the same pre-Covid-19 levels (explained later in this article). Another important requirement is that you actually incur or pay these expenses during the CP, which for most is now defined as the 24-week period immediately after your receipt of the loan proceeds. Amounts spent outside the 24-week period (or eight-week period if elected), or outside one of the four permitted categories of expense, are not forgivable and will need to be repaid. The repayment term is now five years for borrowers who received their loan on or after June 5, and for borrowers who received their loan before that time, they are generally expected to be able to negotiate with their lenders to extend the term from two years to five years.
The CARES Act and subsequent IFRs clarified that expenses which are includible in the borrowers forgiveness application are expenses that are “paid and incurred” during the CP.
To further clarify:
The CARES Act states that the forgiveness of debt under the PPP will not be taxable to the borrower. At this time, it is generally accepted that expenses incurred that were funded by the PPP loan will not be deductible. This is important for borrowers who were able to continue to stay open and generate revenue during their CP. If business operations did not substantially diminish, it is possible a borrower could have more taxable income than expected during 2020 if expenses are disallowed.
Once your business has determined the payments eligible for forgiveness, you will need to complete two additional calculations to determine if such amount is ultimately forgivable. Both calculations are based on your payroll: the first is a measurement of your number of full-time equivalents (“FTEs”), and the second is a measurement of actual salary expense. The purpose of these calculations is to ensure that debt forgiveness is directly related to the purpose of the CARES Act – to keep employees working at wages comparable to pre-COVID-19 levels.
If a business reduces its number of full-time employees during the CP, then the forgiveness amount is reduced by a ratio equal to:
Although borrowers have a choice between the two methods, they are required to use the same method consistently throughout the computation.
There are three different options to determine the reference period, and borrowers can select the one most favorable to them:
FTE reduction “safe harbor”: The CARES Act allows for an FTE reduction “cure”. Many observers thought this safe harbor was a drafting error, but it has been repeated enough times that it is not. So how does it work?
Even if a borrower reduces its headcount during the covered period, it will be deemed to have restored it fully if:
Since the inception of the CARES Act, there have been several FTE exemptions introduced to Borrowers through IFRs and the PPP Flexibility Act. These exemptions allow you to ignore a reduction in FTEs for specific employees:
The writers of the CARES Act likely wanted to ensure that borrowers were hiring back employees at a wage rate that was similar to pre-Covid-19 levels. Thus, they introduced a lever that penalizes companies who reduce wages per employee by more than 25% compared to the first quarter of 2020. For purposes of this calculation, however, businesses only need to consider employees who makes $100,000 or less per year. Removing employees that made over $100,000 from this calculation will help employers “manage” higher payroll without being penalized and, at the same time, incentivize them to fully restore the wages of those making $100,000 or less. The statute compares average weekly salaries during the CP to the average weekly salaries of those employees in January through March of 2020.
Because we are using an eight-week covered period, you have until June 30, 2020, to restore your full-time employment and salary levels for any changes made between February 15, 2020, and April 26, 2020, and thus eliminate the potential reduction in loan forgiveness.
The PPP Flexibility Act. changed the 75%/25% rule to a 60%/40% rule, allowing borrowers to realize a greater benefit from the non-payroll costs they incurred during their covered period. However, the law seemed to introduce a “cliff” effect whereby a borrower would not obtain ANY loan forgiveness if it did not spend at least 60% of its forgivable expenses on payroll. As noted below in an excerpt from a joint statement from the Treasury and SBA, it appears the intent is for the mechanics of this ratio to work in a similar way to the previous rule, meaning that non-payroll costs cannot exceed 40% of the total amount of forgiven costs, thus there is not a scenario where there will be no forgiveness on amounts spent if you do not reach a certain spend on payroll. Borrowers just need to understand that increasing spend on payroll increases the non-payroll costs that will be eligible for forgiveness. This is obviously a welcome clarification for borrowers.
“Lower the requirements that 75 percent of a borrower’s loan proceeds must be used for payroll costs and that 75 percent of the loan forgiveness amount must have been spent on payroll costs during the 24-week loan forgiveness covered period to 60 percent for each of these requirements. If a borrower uses less than 60 percent of the loan amount for payroll costs during the forgiveness covered period, the borrower will continue to be eligible for partial loan forgiveness, subject to at least 60 percent of the loan forgiveness amount having been used for payroll costs.”
Over the course of the last few months, there has been a multitude of changes to the forgiveness calculation. While confusing, almost every change has been borrower-friendly, demonstrating the underlying motivation of the Treasury and SBA to ensure that businesses pay back as little as possible. With most borrowers enjoying an extended 24 week covered period, we expect that will be the case. Stay tuned for more changes and clarifications as we are sure there will be many!