Loan Forgiveness and the PPP Flexibility Act of 2020

Update: June 8, 2020

On June 8, 2020, Treasury Secretary Mnuchin and SBA Administrator Carranza issued a joint statement regarding the PPP Flexibility Act. The statement reaffirms many provisions of the Act and indicates that the SBA will promptly issue additional rules and guidance, including a modified borrower application form and a modified loan forgiveness application. Strangely, however, their interpretation of the 60% payroll cliff that is at odds with the statute. The statement provides as follows:

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.

Based on this language, it appears the SBA is going to “interpret” the statute in a manner that grants proportional forgiveness with the 60% amount as a limit on the amount of overall loan forgiveness – i.e., at least 60% of the loan forgiveness amount must relate to payroll costs. Under normal circumstances, we would highlight the fact that government administrators are not permitted to ignore Congressional mandates that violate the letter and spirit of the law. But as the Nobel-prize-winning songwriter Bob Dylan wrote, “The Times They Are a-Changin.”

Update: June 6, 2020

The President signed the Paycheck Protection Program Flexibility Act of 2020 (the “PPP Flexibility Act” or “Act”) on June 5, 2020.  The PPP Flexibility Act greatly expands the PPP in ways that are intended to be favorable for borrowers.  It also amends the employer payroll tax deferral provision of the CARES Act (enacted March 27, 2020) to expand eligibility to borrowers of PPP loans through December 31, 2020, regardless of when loan forgiveness decisions are made.  This article discusses the new law and tries to put the various provisions in context.  As with the CARES Act, the PPP Flexibility Act contains many areas where guidance is still needed, and hopefully the SBA fills those gaps shortly because millions of borrowers are reaching the end of their 8-week covered period.

Maturity Date and Payment Deferral

Despite the CARES Act maximum 10-year repayment term on PPP loans, the SBA provided a 2-year maturity date for all PPP loans and the CARES Act provided a 6-month payment holiday for principal and interest.  The PPP Flexibility Act extends the repayment period to 5 years for loans made on or after June 5, 2020.  This is helpful for new borrowers that do not obtain full loan forgiveness, though we expect that most borrowers (with proper planning) will be able to obtain significant forgiveness given the breadth of the dispensations in the PPP Flexibility Act.  For borrowers who obtained a PPP loan before June 5, 2020, the PPP Flexibility Act contemplates that borrowers would approach their lender to try and negotiate an extension to their existing loan term, though nothing currently requires lenders to acquiesce.

The PPP Flexibility Act extends the borrower’s payment deferral from 6 months to the date the SBA remits the loan forgiveness amount to the lender.  The deferral includes any payment of principal, interest, and fees that may be due the lender.  This is helpful for borrowers that do not obtain 100% loan forgiveness because it greatly extends the payment deferral – until early or mid-2021 for borrowers that choose the default 24-week covered period.  The Act also creates a disincentive for borrowers to delay the filing of their loan forgiveness applications by putting an end date on the payment deferral.  If a borrower does not apply for loan forgiveness within 10 months after the end of its covered period, then payments on the loan begin at that time.  We presume the SBA may impose its own filing deadline when it issues a new version of the loan forgiveness application to account for the revisions to the PPP by the Act.

Extension of Covered Period

Under the CARES Act, the covered period is the 8-week period beginning on the date the loan proceeds are disbursed to the borrower.  The SBA’s loan forgiveness application later allowed for an alternative payroll covered period (“APCP”) that aligns with the borrower’s payroll cycle for any borrower who has a biweekly (or more frequent) payroll cycle.  The PPP Flexibility Act now retroactively defaults all PPP loans to a 24-week covered period and allows for an election to revert to an 8-week period.  The Act is flexible in that it does not set an end date by which the election must be made, but it is inflexible in that it does not allow for the term of the covered period to be anything other than 8 or 24 weeks, e.g., 16 weeks.  For borrowers that do not elect out of the 24-week covered period, the June 30, 2020 rehire/wage restoration date is extended to December 31, 2020.

The extension of the covered period to 24 weeks at first blush seems favorable for all borrowers, but closer scrutiny reveals that the 8-week election will be beneficial for certain borrowers, depending on the SBA’s interpretations of the Act.  For example, taking a strict interpretation of the language in the PPP Flexibility Act, if a borrower uses the PPP to retain all 10 of its employees, runs out of money after eight weeks and closes its business, then it will suffer a reduction in forgiveness under the headcount rule.  Its average weekly number of employees would consist of eight weeks of 10 FTEs, and sixteen weeks of 0 FTEs, for an average of 3.3 FTEs (80 FTEs / 24 weeks).  Thus, the borrower would suffer a 2/3 reduction in its total spending on payroll and nonpayroll costs, leaving a 1/3 repayment obligation.  Conversely, the more employees that the borrower retains after the initial 8-week period, and the longer they are employed, the more beneficial the 24-week period becomes.  Either way, this adds another dimension to borrowers’ loan forgiveness planning.

The 24-week covered period seems most suited to businesses that maintain operations after week 8 because the increased spending during the longer covered period more than makes up for any headcount or wage reductions.  It will also be beneficial to borrowers who receive the loan but for whatever reason did not use the funds during the initial eight weeks.  Consider the following example:  borrower receives a $100 PPP loan but spends $50 on half its employees during the first eight weeks, and then increases the FTE count to 75% during the final 16 weeks of the 24-week covered period.  Assume no overhead costs, no wage reductions, and all employees are paid equally.  After the first 8 weeks, the borrower spends another $150 during weeks 9 through 24 ($75 per each eight-week period).  Thus, borrower’s total spend on payroll costs would be $200 and even with a headcount reduction of 1/3 (average weekly employment during each eight-week period would be 50%, 75%, which equals  66.66%), its loan forgiveness amount would exceed the amount of the loan. The loan forgiveness amount would be $133 ($200 x 2/3), which is greater than the principal amount of the loan plus interest so there would be no repayment obligation.

We also assume that the cash compensation cap will be increased proportionately to the new covered period.  Because $15,385 was the cap for 8 weeks, we assume the new cap for the 24-week period will be $46,154 ($100K x 24/52).

Extension of the Rehire Rule

Recall that loan forgiveness is calculated without regard to reductions in headcount or wages during the period from February 15, 2020 to April 26, 2020 (the “window period”) if no later than June 30, 2020, the borrower eliminates the reduction in FTE headcount or the reduction in any individual employee’s wages beyond the 25% threshold, as applicable.  This rule, as we’ve written previously, allows for a disproportionate elimination of reductions in forgiveness.  The PPP Flexibility Act changes this date to December 31, 2020 for borrowers that use the 24-week covered period.

The extension of the rehire/wage restoration date has a number of implications.  First, it means that most borrowers who retain the 24-week covered period will not be filing their loan forgiveness applications until early 2021.  Second, this creates greater uncertainty for borrowers because it extends the period of time between when they exhaust their PPP money and when they have to rehire/restore wages.  Last, it means that many borrowers will not receive a decision on their loan forgiveness applications until after they file their 2020 income tax returns.  Why does this matter?  It matters because if a taxpayer obtains loan forgiveness on a PPP loan, it is not permitted to claim tax deductions for the expenses that gave rise to the forgiveness, according to the IRS.  Thus, taxpayers will claim deductions on their 2020 income tax returns and then have to reverse those deductions if they obtain loan forgiveness.  The IRS likely will take the position that claiming the deductions in 2020 is improper because section 265 disallows the deductions “whether or not [the loan forgiveness amount] is received or accrued,” but this nonetheless remains a compliance issue for the IRS, which may be compounded by the fact that taxpayers have no general duty to file amended tax returns, even if their tax professional advises them to file one.  The decision to file an amended return remains with the borrower.

Expansion of FTE Reduction Exceptions

The SBA’s loan forgiveness application provides four exceptions where a borrower’s FTE count is not reduced even though there are less employees employed during the covered period than were employed during the reference period.  Generally, the exceptions are (i) any position for which the borrower made a good-faith, written offer to rehire an employee during the covered period which was rejected by the employee, (ii) employees who were fired for cause, (iii) employees who voluntarily resigned, or (iv) employees who voluntarily requested and received a reduction of their hours.

The PPP Flexibility Act legislates two new, and potentially broad, exceptions.  First, it exempts a “proportional reduction” in the number of FTEs if the borrower, in good faith, can document an inability to rehire individuals who were employees on February 15, 2020 and an inability to hire similarly qualified employees for unfilled positions on or before December 31, 2020.  The second exemption applies if a borrower can document an inability to return to the same level of business activity as it was operating at before February 15, 2020, due to compliance with requirements or guidance issued by the CDC, OSHA or HHS during the period from March 1, 2020 to December 31, 2020 and related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19.

Limitation on Forgiveness: The Payroll Cliff

After the CARES Act and prior to the PPP Flexibility Act, the SBA imposed a 75%/25% requirement on borrowers such that no more than 25% of the loan forgiveness amount could be used on overhead (i.e., nonpayroll) costs.  Mechanically, the SBA’s loan forgiveness application imposed this limitation by taking total payroll costs considered for forgiveness, dividing by 75%, and then setting that as a ceiling on the loan forgiveness amount.  The PPP Flexibility Act imposed a different requirement, requiring borrowers to spend at least 60% of the loan amount on payroll costs or they will not be eligible for any loan forgiveness.  This creates a cliff effect where no forgiveness will be granted if the 60% hurdle is not met, though borrowers are free to spend more than 60% if they choose.  It has been reported that at least one Senator is uncomfortable with this rule and has asked the SBA to mitigate its impact in future regulations.

If you have questions regarding the PPP Flexibility Act, or the loan forgiveness process, please reach out to your Withum advisor.