April 30, 2020

Plan Now For Paycheck Protection Program Loan Forgiveness

Written By

Thomas E. Rutledge
Member, Stoll Keenon Ogden PLLC

The Paycheck Protection Program (the “PPP”) has provided some $660 billion in loans to businesses to fund payroll and other expenses. We have reviewed aspects of the PPP in several prior articles including HERE and HERE.

One of the most enticing elements of the PPP is that while the funds are disbursed as a loan at very favorable terms (2-year term, no payments for six months and a 1 percent interest rate; interest does accrue during the six-month payment deferral period), the loans can be forgiven. If forgiven, what was a loan becomes essentially a grant. So, if your business received a PPP loan, or you are in the process of receiving a loan, start planning now for applying for forgiveness.

Before getting to the details of what is required for a PPP loan to be forgiven, let’s cut to the chase. The guidelines for forgiveness are not as clear as we might like. You should start planning now to document your use of the PPP loan funds so that you can make the case that your loan should be forgiven. You should now be talking with your internal staff and your external advisors about maintaining necessary records. And you should be talking with your lender about what they will be looking for in the way of documentation.

The Forgiveness Process

The bank or other financial institution that made the PPP loan to your company will be deciding if the requirements for forgiveness have been satisfied. Keep in mind that, as of today, no lender has ever forgiven a PPP loan; the first applications for forgiveness will not be submitted until at least eight-weeks after the first PPP loans were disbursed. Now is a good time to call your lender and ask what they will want to see. Likely your lender is still working on the checklist that they will employ, so it will not be surprising if you do not receive a comprehensive answer. Still, knowing more is better than knowing nothing, and your dialogue may help your lender later help you. The CARES Act, which created the PPP loan program, at section 1106(e) requires that a borrower submit to the lender an application for forgiveness setting forth:

(1) documentation verifying the number of full-time equivalent employees on payroll and pay rates for the periods described in subsection (d), including—
(A) payroll tax filings reported to the Internal Revenue Service; and
(B) State income, payroll, and unemployment insurance filings;

(2) documentation, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments;

(3) a certification from a representative of the eligible recipient authorized to make such certifications that—
(A) the documentation presented is true and correct; and
(B) the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, or make covered utility payments; and

(4) any other documentation the Administrator determines necessary.
So now let us turn our attention to making your application for forgiveness successful.

Three Issues

There are essentially three hurdles that must be satisfied in order for your PPP loan to be forgiven, namely:
1. Application of funds within the eight-weeks after loan disbursement;
2. Disbursement of PPP loan proceeds only for approved purposes and within prescribed limits; and
3. Calculation of employee-based limits (of which there are two) on forgiveness.

The Eight-Week Requirement

In order to be forgiven, the PPP loan proceeds must be disbursed within eight weeks of receipt; this eight-week period is in the statute and the regulations refer to it as the “covered period.” Especially for those companies that received loans in the initial funding tranche, the clock is running. Funds that are not applied to permitted purposes (see below) within that eight-week period are not subject to being forgiven. This eight-week clock is going to have some curious effects. For example, your lease payments are due the first of the month. You received your PPP loan on the 17th. You may use your loan to pay for the lease obligation from the 17th thru the end of that month. Also, at the tail end of the eight-week period, which ends on the 16th, you can use the PPP funds to pay your lease through the 16th. You are going to need to calculate the appropriate pro-ration of your lease costs to be sure you are using PPP loan funds only for the obligations that exist during the eight-week period.

As is expanded upon below, most PPP loan proceeds, in order to be forgiven, need to be applied to payroll. You need to compare your eight-week calendar with your payroll calendar. No doubt they do not match-up. Assume your eight-week period runs out six days into a fifteen day pay period. Either your internal payroll function or your outside payroll provider should, as of the end of the six-day period, generate a report as to where the payroll obligations stands as of that day. You can utilize PPP funds for the payroll expenses of that period for that amount. There is of course a similar calculation to be run as of the day the PPP funds were received.

Yesterday, April 29, The American Institute of Certified Public Accountants (AICPA) requested that new guidance be issued to the effect that the eight-week period be deemed to begin consistent with the borrower’s pay period so as to avoid the need for stub-periods. Whether the SBA will revise the existing rule to adopt this request remains to be seen.

Approved Purposes

PPP loan proceeds, in order to be forgiven, may be applied only to certain purposes.
The FAQ published by the Small Business Administration (“SBA”) provides in part that PPP funds may be applied to:

• Payroll costs, including benefits;
• Interest on mortgage obligations in force before February 15, 2020;
• Rent, under lease agreements in force before February 15, 2020; and
• Utilities, for which service began before February 15, 2020.
From there, further guidance from the SBA requires that not less than 75 percent of the loan proceeds be applied to payroll costs and benefits, which makes it crucial to understand what are the permitted “payroll costs.” That same SBA FAQ provides the payroll costs include:
• Salary, wages, commissions, or tips (capped at $100,000 on an annualized basis for each employee);
• Employee benefits including costs for vacation, parental, family, medical, or sick leave;
• Allowance for separation or dismissal;
• Payments required for the provisions of group health care benefits including insurance premiums;
• Payment of any retirement benefit; and
• State and local taxes assessed on compensation.

Note, however, that PPP funds cannot be used for either (i) the Emergency Paid Sick Leave Act (“EPSLA”), which entitles workers to up to 80 hours of paid sick time when they are unable to work for certain reasons related to COVID-19, or (ii) the Emergency Family and Medical Leave Expansion Act (“Expanded FMLA”), both under the Families First Coronavirus Response Act (the “FFCRA”); here is a review of those programs.

If you have employees in either of those programs you need to be sure you account for that and exclude those funds from your PPP calculations. Also, while state and local taxes imposed upon the employer are permitted uses of PPP funds, the employer’s portion of federal tax obligations such as the FICA (Social Security) match are not within the permitted purposes.

Interest on mortgages may be paid with PPP loan funds, but not on the principal. And no, you cannot prepay mortgage interest.

The $100,000 cap on per-employee compensation is exclusive of benefits. Assume you have an employee whose annual compensation is $120,000 ($10,000 per month). For purposes of PPP loan forgiveness, his or her compensation is capped at $100,000 ($8,333 per month). That employee also receives family health insurance valued at $1,150 per month. Both the $8,333 and the $1,150 are permissible applications of the PPP loan funds.

Here are some practices you can employ now in order to demonstrate that your PPP loan funds were used for permitted purposes:

First, keep contemporaneous records of what the funds were used for and why. Even if the funds were not deposited into a distinct bank account, set up a virtual account in your accounting software to track the depletion of those funds. When funds are applied, such as by writing a check from your operating to your payroll account, document that funds were withdrawn from the PPP funds to cover that portion of your payroll that falls within PPP guidelines for forgiveness. Make a record of how you calculated the correct amounts (pro-ration of lease expenses, stub periods for payroll and the exclusion of non-PPP purposes such as employer FICA taxes) tied to an entry for the disbursement. It is going to be easier to ask forgiveness if you can show efforts at compliance; those efforts may well ring hollow if you do not have a contemporaneous record of efforts at compliance.

Second, as noted above, talk with your lender and demonstrate an effort to follow the rules. Inquire as to what level of detail they will be looking for when reviewing an application to forgive a PPP loan. And then, if possible, exceed those expectations.

Third, keep a keen eye on the calendar. Make sure you know when you received the loan proceeds and be sure you know when the eight-week period for their application comes to an end. On that point, “eight-weeks” (56 days) is an atypical period. Does it include the day the loan was funded? What about when the loan was funded mid-afternoon? Probably “yes.” You might start your discussion with your lender on agreeing as to the date on which your eight-week period will close.

If, for whatever reason, you use PPP loan proceeds other than for a permitted purpose, you must repay that amount immediately. Those amounts will not be forgiven, and you may not repay them over the two-year term of the PPP note.

Employee-Based Limits on Forgiveness

For companies without stable employment levels, this requirement may be an issue. That said, all employers need to be aware of it as it appears that there is a drafting error in the statute.

In submitting your PPP application, you provided information as to your payroll either based upon 2019 figures (likely you took this approach if your business is seasonal) or for 12-months ending in 2020. Keep in mind the full name of the PPP, the Paycheck Protection Program. Its goal is to maintain payroll, and your ability to have your PPP loan forgiven is dependent in part on maintaining the payroll that was certified in your loan application. This expectation is accounted for under two rules set forth in CARES Act §§ 1106(d)(2) and 1106(d)(3).

First, the amount of your PPP loan that may be forgiven is limited to the extent you have a reduction in the number of full-time equivalent employees (“FTEE”). The loan forgiveness limit is a fraction in which the numerator is the average FTEE over the eight-week covered period. The denominator is:

a. the average FTEE between February 15, 2019 and June 30, 2019 or March 1, 2019 and June 30, 2019; or
b. the average FTEE between January 1, 2020 and February 29, 2020.

Seasonal employers are required to use (a); other employers may use (a) or (b) and presumably will use the smaller of the two. That fraction will be applied to the amount of the PPP loan (and not just the portion applied to payroll expenses) in determining a cap on the amount that may be forgiven.

If you have laid-off or terminated employees, you can make new hires (they do not have to be the former employees) to bring your FTEE census back to where it was.

Ultimately you want that denominator as close to the numerator as is possible so that the ratio is 1. Even if you have increased your FTEE so that the ratio is higher than 1, it is capped at 1.

Second, if you have employees who were making less than $100,000 on an annual basis in 2019, and they took a pay cut in the eight-week “covered period” of more than 25 percent, then the amount that can be forgiven will be reduced, apparently on a dollar-for-dollar basis. For example, if an employee was making $22 per hour, and is reduced to $15 per hour, the reduction in compensation exceeds 25 percent. Under the current interpretation, the loan forgiveness will be reduced by $1.50 per hour (i.e., the reduction in compensation exceeding the 25 percent cap) worked by that employee. Exactly how it will be reduced is not yet clear; new guidance from the SBA has been promised. But you need to be aware of that risk and should consider rescinding any reductions in compensation for the eight-week period. At the same time, if employees making more than $100,000 in 2019 have taken pay cuts, those reductions will not impact how much of your PPP loan may be forgiven.

How About an Example

Okay, so let’s look at a worst-case scenario (well, not worst; the PPP loan funds could be embezzled). In 2019, our borrower had 100 employees, none making more than $100,000 per year (monthly payroll of $320,000). On March 1, 2020, our borrowed laid off twenty of those employees, reducing his FTEE by twenty percent, and for the remaining employees reduced the average hourly wage from $20 to $14, a 30 percent pay cut. Weekly payroll is now $44,800. Assume our borrower receives a PPP loan for $800,000 (2.5 * 2019 average monthly payroll). The loan is disbursed on April 1, and that starts the eight-week “covered period.” During that period our borrower applies the loan proceeds as follows: $358,400 to payroll costs (80 FTEE * $14 per hour), $5,000 to mortgage interest, and $2,000 to other permitted expenses such as utilities.

First, as of the end of the eight-week period the unapplied balance of the PPP Loan ($800,000 less $358,400 less $5000 less $2000) must be returned to the lender. So, the question is what portion of the $366,200 may be forgiven?

During the eight-week period following receipt of the loan, our borrower incurred $358,400 of payroll costs ($14 hourly rate * 40 hour per week * 8 weeks * 80 FTEE). The FTEE in the eight-week covered period was 80 percent of the prior period. So, the amount that can be forgiven is first reduced by 20 percent, leaving $292,960 ($358,400 * .8) that may be forgiven. Employer also reduced wages for all employees by 30 percent during the eight-week period versus what it had been in the last quarter of 2019. Every dollar of reduction beyond 25 percent results in a dollar-for-dollar reduction in the amount forgivable, that amount being $25,600 ($1 per hour * 40 hours per week * 8 weeks in covered period * 80 FTEE). Ergo, of the $366,200 that potentially could have been forgiven, only $267,360 (($366,200 * .8) – $25,600) is eligible for forgiveness.

But There Is Always a Glitch

Okay, that is how (it would seem) that it is to work. There would appear to be, however, a drafting error in the CARES Act as to employee compensation. Specifically, CARES Act § 1106(d)(3)(A) provides that:

The amount of loan forgiveness under this section shall be reduced by the amount of any reduction in total salary or wages of any employee described in subparagraph (B) during the covered period that is in excess of 25 percent of the total salary or wages of the employee during the most recent full quarter during which the employee was employed before the covered period.

The problem is subtle: Loan forgiveness is limited if an employee’s wages in the eight-week covered period are reduced by more than 25 percent of what they earned in the full quarter before the eight-week covered period. Assume no reduction in hourly pay and that employee makes $15 per hour. In the eight-week covered period total compensation is $4,800 ($15 * 40 * 8). In the prior quarter that same employee made $7,200 ($15 * 40 * 12). That employee, whose hourly compensation has not been reduced, made only 66.66 percent in the eight-week covered period of what she made in the prior quarter. And under CARES Act § 1106(d)(3)(A), as written, on a dollar-for-dollar basis, for every hour this employee works, the amount of PPP loan forgiveness is reduced by $1.25 (the 8.33 percent differential between 75 percent and 66.66 percent * $15).

Further Developments

If and when further guidance as to PPP loan forgiveness is published, we will supplement this review.
Other Open Issues

Discharge of Indebtedness Income

Discharge of Indebtedness Income

Normally, if you borrow money from the bank, and then do not have to pay it back, barring certain exceptions in the tax code such as upon bankruptcy, you have discharge of indebtedness income, Code §§ 61(a)(11), 108. Discharge of indebtedness income is just that; you have to pay income taxes on the amount of the loan that is discharged. The CARES Act, which created the PPP, provides that if a PPP loan is forgiven, the loan recipient does not have any discharge of indebtedness income – for purposes of the federal tax code. However, the CARES Act simply declared this to be the result without amending Code § 108. That matters because while states, for purposes of their tax codes, typically follow the treatment under federal Code § 108, there is no policy to handle one-off federal treatments such as the CARES Act. In consequence, there is a debate going on as to whether upon forgiveness of a PPP loan your company will for state tax purposes have discharge of indebtedness income.

Deductibility of Expenses Paid for With Forgiven PPP Loan Proceeds

Another question that is pending is the degree to which expenses funded with a forgiven PPP loan may be deducted from taxable income. All else being equal, payments toward payroll or mortgage interest are deductible in determining taxable income. But if you receive a PPP loan, and the loan is forgiven, you have received a non-taxable grant. Can you both receive those PPP funds and then take a tax deduction for the amounts paid out? Tax professionals are debating the question, and the question has been presented to the Treasury Department.


Stoll Keenon Ogden understands that these are trying times for our clients and our country. Our firm operations have continued uninterrupted and our attorneys are equipped to serve as we always have – for more than 120 years.

Please also be sure to consult the Stoll Keenon Ogden Coronavirus Resource webpage for additional articles and information related to the latest information on new laws and directives enacted by federal, state, and local governments in response to the Coronavirus pandemic.

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