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Paycheck Protection Program: Analysis of Forgiveness

The “front end” of the Paycheck Protection Program (“PPP”) was intense for applicants and professional advisors alike. The law itself is ambiguous, and the clarifying guidance that followed was often sparse on details and filled with confusing language. This created no shortage of anxiety as businesses attempted to participate within a banking system that was entirely unprepared. As we move on from the first chapter of this story, we are now in a waiting game to see who gets funded and how much.

But while we wait, why not make the most of our “free time” by analyzing what the next chapter might look like: calculating forgiveness. The CARES Act lists the expenses that are subject to forgiveness and establishes a calculation to determine how much of your loan should be forgiven. Understanding each component of this calculation is important to maximize the benefit companies are entitled to receive.

What is forgivable?

The CARES Act lists four categories of expenses that are forgivable. This means that your PPP loan is forgivable to the extent you spend the proceeds of your loan on these four categories, provided you maintain the headcount and salaries of employees at the same pre-Covid-19 level, the loan will be forgiven. Another important requirement is that you actually pay for these expenses during the “covered period,” which is defined as the 8-week period immediately after your receipt of the loan proceeds. Amounts spent outside the 8-week period, or outside one of the four permitted categories of expense, are not forgivable and will need to be repaid within two years.

  1. Payroll costs – What constitutes “payroll costs” was a hot topic as companies were applying for PPP loans. When the dust settled, the SBA clarified that payroll costs include gross salaries and wages of employees up to a cap of $100,000 per year, employer-paid health insurance, employer-paid 401k matching contributions, and employer-paid state and local taxes on payroll (e.g., unemployment insurance), among other things. Payroll costs do not include the employers portion of payroll tax expenses such as Social Security and Medicare. The SBA issued Interim Final Rules on April 2, 2020, and these rules added a requirement that at least 75% of the loan forgiveness amount must be attributable to payroll costs.
  2. Rent Obligations – This includes payments under a lease agreement in force before February 15, 2020. This most likely refers to leases of real property, such as office space.
  3. Utilities – The CARES Act defines utilities narrowly to include: electricity, gas, water, transportation, telephone, or internet service for which service began before February 15, 2020.
  4. Interest – The CARES Act uses a term “covered mortgage obligation,” to describe which interest payments could be subject to forgiveness. Interest payments can be for any debt obligation that is a liability of the borrower incurred before February 15, 2020. It does not include payments or prepayments of principal. The Act does stipulate however that the underlying debt must be a “mortgage on real or personal property.” This would include debt on real property that is secured by a traditional mortgage lien as well as working capital lines of credit and other indebtedness where a UCC-1 is filed on the borrower’s personal property. This definition does not appear to include unsecured debt.

What are the tax implications?

The CARES Act states that the forgiveness of debt under the PPP program will not be taxable to the borrower.

How to calculate your maximum forgiveness

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 your 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.

Headcount Analysis:

  • If a business reduces its full-time employees during the “covered period” (defined as the 8-week period after the company receives its first disbursement of PPP funds), the forgiveness amount is reduced by a ratio defined as:
    • The average number of FTEs during the covered period (numerator) divided by the average number of FTEs during the base period described below (denominator).
      For the purposes of the calculation, the current thinking is that one FTE equals one employee that worked at least 30 hours in a week.
  • There are three different options to determine the base period, and borrowers can select the one most favorable to them:
    • Using 2019 Information –the average number of FTEs per month from February 15, 2019, through June 30, 2019
    • Using 2020 Information –the average number of FTEs per month from January 1, 2020, to February 29, 2020
    • Seasonal Businesses –the average number of FTEs per month from February 15, 2019, through June 30, 2019

Let’s look at an example:
• Loan amount: $500,000, (assuming you spent all of the funds on qualifying expenses)
• Average number of FTEs from February 15, 2019 to June 30, 2019: 75
• Average FTEs during “covered period” following your first loan disbursement: 55
PPP Calculation: 55/75= 73%
Maximum loan forgiveness: $500,000 * 73% = $365,000
This tells us that the company will need to repay $135,000 of the loan.

Wage Analysis:
The writers of the CARES Act likely wanted to ensure that companies were hiring back employees at a wage rate that was similar to pre-Covid-19 levels. Thus, they introduced a lever that penalized companies who reduced wages per employee by more than 25% compared to the most recent quarter before the PPP loan was made. 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 an eight-week period to a three-month period, comparing apples to oranges, we expect further guidance will clarify the method of calculation.

Let’s look at an example:
Loan issue date: April 1, 2020
Employee’s salary in Q1 2020: $20,000
Employee’s salary during eight-week covered period: $13,000
Amount of forgiveness reduction: ($20,000 – $13,000) – ($20,000 X 25%) = $2,000

How can you “correct” reductions of forgiveness?

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. But it is currently unclear mechanically how you would employ the correction. We recommend looking for further clarifying guidance.

If you have any questions, please contact a member of Withum’s SBA Financial Assistance Services Group.

Now is the time to start planning

The loan forgiveness process will be administered by your bank and we expect they will request supporting documentation to validate your conclusions. Once a loan is received from the PPP program, it is important to be strategic when thinking about how to bring employees back, how to spend the funds, and how to ensure you receive the maximum amount of loan forgiveness. Now is the time to start planning for the next few months!

Reminders of What to Do
Use your proceeds on specifically covered expenses
Use at least 75% of the proceeds on payroll costs
Understand the two calculations which can reduce forgiveness
Collect good documentation of the use of funds so you can apply for forgiveness

SBA Financial Assistance Services

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