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How to Seek Paycheck Protection Program Loan Forgiveness

August 19, 2020

Thomas E. Rutledge
Member, Stoll Keenon Ogden PLLC
(502) 560-4258
thomas.rutledge@skofirm.com

The PPP Loan Application Window Is Closed

The initial cut-off for PPP loan applications was June 30. Legislation signed on July 4 extended that date through August 8. With that day now come and gone, and there appearing to be no appetite in Congress to reopen the program, except for those few companies who may have applications still in progress, all the PPP loans that are going to be made have been made. Those loans totaled more than $525 billion.

PPP Loan Forgiveness

The focus now is upon PPP loan forgiveness, especially the earliest loans for which the original eight-week-covered period has expired. Before getting into the details, a word of caution – the forgiveness application is not something you should try to do at home. For example, there are aspects of the limitations upon forgiveness that are not fully explored in the forgiveness application and the related instructions. While “That’s not fair” is a valid retort, the facts do not change. Review of your application by an attorney or accountant who is well versed in the PPP and its (oft arcane) rules may increase the amount for which you can claim forgiveness, or at minimum not introduce mistakes in your application that may invite additional scrutiny by your lender.

You will submit your application for forgiveness to your original PPP lender. The SBA has provided forms (there is a long form and a short form) that you will need to complete, and which will need to be supported with additional information. The forms detail what additional information need to be provided. You will also need the related instructions; here are links to the long form instructions and to the short form instructions.

Your lender is required to decide on forgiveness within sixty days after the application is complete. If your application is incomplete, the sixty-day period will not begin to run until you submit the missing information.

Much has been made of efforts early in the program’s life to effectively shame borrowers into returning borrowed funds on the basis that they were not truly eligible because they had other sources of liquidity with which to weather the Covid-19 storm (notwithstanding that while for other SBA loans the borrower needs to show no alternatives, a requirement dropped in PPP). Ultimately, loans of less than $2 million will be assumed to have been necessary, and they will not be further reviewed as to whether the funds were necessary. Alternatively, all loans of $2 million or more will be reviewed by the SBA as to whether the borrower had alternative sources of liquidity. See Paycheck Protection Programs Loans – Frequently Asked Questions (FAQs), question 31. That review is separate and apart from the loan forgiveness determination by your lender. The relationship of the review of the loans in excess of $2 million will be discussed in a forthcoming SKO Insider.

But a reality check is necessary. While the SBA opened the portal through which banks will submit the loan forgiveness determinations on August 10, many banks have announced that they are not yet ready to process forgiveness applications. For example, PNC Bank has announced that it will start accepting forgiveness applications in late August, and on August 11th, JP Morgan announced it would begin accepting applications “in the coming weeks.” You need to coordinate with your lender as to when they will accept your PPP loan forgiveness application.

There are Five Primary Limitations on PPP Loan Forgiveness

PPP loans may be forgiven, at which time the loan (to the extent forgiven) becomes essentially a grant. More below on the tax and accounting treatment of a PPP loan and forgiveness. But first let’s talk about the five primary limitations upon forgiveness.

One
First, only loan funds expended on proper purposes during the “covered period” may be forgiven. If and to the extent the borrower received PPP loan funds that within the “covered period” are not applied to permitted expenses (e.g., payroll, mortgage interest and rent payments), those funds need to be returned to the lender, where they will likely be treated as a partial repayment of the loan. You are not allowed to keep the PPP loan funds as “cheap money” (i.e., one percent for five years) as your “rainy day fund.” PPP funds expended on other than permitted purposes are not only not going to be forgiven but may well lead to criminal charges.

Two
Second, the amount of potential forgiveness is reduced to the extent 60% of the loan amount was not applied to payroll costs. When the PPP was launched, the Treasury Department issued a regulation requiring that at least 75% of the loan proceeds be applied to payroll expenses, a requirement we previously reviewed. The PPP Flexibility Act reduced the threshold to 60t%. The 60% limit is a not a cliff (i.e., if 60% is not expended on payroll costs then none of the loan is subject to being forgiven). Rather, there results a reduction in the percentage of the loan that may be forgiven.

Three
Third, there is a limitation on forgiveness based upon any reduction in the number of full- time employee equivalents (“FTEE”) of the borrower. This limitation is a fraction (which may not exceed 1) calculated as:

the average number of full-time equivalent employees per month employed by the eligible recipient during the covered period

over

the average number of full-time equivalent employees per month employed by the eligible recipient during the period beginning on February 15, 2019 and ending on June 30, 2019, or the average number of full-time equivalent employees per month employed by the eligible recipient during the period beginning on January 1, 2020 and ending on February 29, 2020;

The CARES Act goes on to provide that “[T]he average number of full-time equivalent employees shall be determined by calculating the average number of full-time equivalent employees for each pay period falling within a month.” The borrower will want to make both period calculations and use the lower amount as the denominator. Note that persons who have voluntarily resigned, been fired for cause, or who requested a reduction in hours are not included in the calculation. Further, it applies only to persons compensated $100,000 or less in 2019.

A FTEE is someone who works 40 or more hours per week. Part-time employees may be treated on a per hour worked basis (e.g., an employee working 30 hours a week is .75 of a FTEE) or all part-time employees may be treated as .5 of a FTEE. The same test must be used across the borrower’s operations. PPP borrowers with a significant number of part-time employees will want to run both calculations to see which is more advantageous. A borrower with mostly part-time employees working 30 hours a week will want to rely on the per-hour calculation while a borrower whose employees typically work less than 20 hours a week may benefit from the .5 FTEE equivalency across the board.

There is a safe harbor to this limitation that is reviewed below.

Four
Fourth, if and to the extent that the borrower has reduced employee compensation by more than 25% from prior compensation levels, there is a dollar-for-dollar reduction in the amount that may be forgiven. This limitation applies only to employees who were making $100,000 or less per annum. An employee will not be counted twice in these two limitations; the termination of a FTEE will not as well be treated as a 100% reduction in compensation.

There is a safe harbor for this limitation on forgiveness that is discussed below.

Five
Fifth, under an “Interim Final Rule” (a concept of which Orwell would be proud) titled Business Loan Program Temporary Changes; Paycheck Protection Program-Revisions to First Interim Final Rule, there is a special rule as to the forgiveness of PPP loan proceeds used to pay compensation to the borrower’s owners:

owner compensation replacement, calculated based on 2019 net profit as described in Paragraph 1.b. above, with forgiveness of such amounts limited to eight weeks’ worth (8/52) of 2019 net profit (up to $15,385) for an eight-week covered period or 2.5 months’ worth (2.5/12) of 2019 net profit (up to $20,833) for a 24-week covered period, but excluding any qualified sick leave equivalent amount for which a credit is claimed under section 7002 of the Families First Coronavirus Response Act (FFCRA) (Public Law 116-127) or qualified family leave equivalent amount for which a credit is claimed under section 7004 of FFCRA.

These limitations were expanded upon in a subsequent Interim Final Rule, Business Loan Program Temporary Changes; Paycheck Protection Program—Revisions to Loan Forgiveness and Loan Review Procedures Interim Final Rules, it providing:

c. Are there caps on the amount of loan forgiveness available for owner-employees and self-employed individuals’ own payroll compensation?

Yes. For borrowers that received a PPP loan before June 5, 2020 and elect to use an eight-week covered period, the amount of loan forgiveness requested for owner- employees and self-employed individuals’ payroll compensation is capped at eight weeks’ worth (8/52) of 2019 compensation (i.e., approximately 15.38% of 2019 compensation) or $15,385 per individual, whichever is less, in total across all businesses. For all other borrowers, the amount of loan forgiveness requested for owner-employees and self-employed individuals’ payroll compensation is capped at 2.5 months’ worth (2.5/12) of 2019 compensation (i.e., approximately 20.83% of 2019 compensation) or $20,833 per individual, whichever is less, in total across all businesses. In particular, C-corporation owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement and health insurance contributions made on their behalf. S-corporation owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement contributions made on their behalf, but employer health insurance contributions made on their behalf cannot be separately added because those payments are already included in their employee cash compensation. Schedule C or F filers are capped by the amount of their owner compensation replacement, calculated based on 2019 net profit. General partners are capped by the amount of their 2019 net earnings from self-employment (reduced by claimed section 179 expense deduction, unreimbursed partnership expenses, and depletion from oil and gas properties) multiplied by 0.9235. For self-employed individuals, including Schedule C or F filers and general partners, retirement and health insurance contributions are included in their net self-employment income and therefore cannot be separately added to their payroll calculation. The Administrator, in consultation with the Secretary, determined that it is appropriate to limit the forgiveness of owner compensation to either eight weeks’ worth (8/52) of their 2019 compensation (up to $15,385) for an eight-week covered period or 2.5 months’ worth (2.5/12) of their 2019 compensation (up to $20,833) for a 24-week covered period per owner in total across all businesses.

Well, I for one am glad that has been cleared up. There are other rules in this area, including one that addresses the treatment of the compensation arrangements of crewmen on fishing boats; I interpret those rules as likely applicable to sharecroppers. The point is that the rules on PPP loan forgiveness when the proceeds have been used to replace compensation for owners (partners in partnerships, members in LLCs, and shareholders in C and S corporations) is far more complicated than it appears at first glance. For that reason (as well as many others), professional review of your forgiveness application is recommended.

More on Calculating FTEE

Borrowers, in calculating FTEE, are permitted to add back: (1) any positions for which the employer made a good-faith, written offer to rehire, which was rejected and (2) any employees who were fired for cause, voluntarily resigned, or voluntarily requested and received a reduction in hours (i.e., shifted from full time to part time). But no double dipping; if for example an employee is fired for cause (no reduction in numerator) you cannot as well count the new hire (i.e., add the replacement employee to the numerator).

Pursuant to the PPP Flexibility Act, which we previously reviewed here, and the implementing forgiveness application, a borrower may add back any positions for which the employer made a good-faith written offer to restore any reduction in hours during the covered period that was rejected by the employee. This provision addresses an involuntary reduction in hours.

In addition, the forgiveness application added two limitations on the reduction exception for rejected offers to rehire. First, the individual to whom the offer to rehire is made must have been an employee on February 15, 2020. Second, the employer must be “unable to hire similarly qualified employees for unfilled positions on or before December 31, 2020.”

This second limitation is troubling. Neither “unable to hire” nor “similarly qualified” are defined in the application or the regulations. More troubling is the December 31, 2020 deadline. Is a borrower who hopes to rely upon this provision required to continue to make hiring efforts through the end of the year and only then submit its loan forgiveness application?

FTEE Reduction Safe Harbors

The PPP loan forgiveness application provides two additional safe harbors related to FTEE reductions. Compliance with either safe harbor eliminates any decrease in loan forgiveness based upon a reduction in FTEE levels.

(1) The “Due to COVID-19” Safe Harbor

This new safe harbor was created by the PPP Flexibility Act. As implemented by the loan forgiveness application instructions: “The Borrower is exempt from the reduction in loan forgiveness based on a reduction in FTE employees described above if the Borrower, in good faith, is able to document that it was unable to operate between February 15, 2020, and the end of the Covered Period at the same level of business activity as before February 15, 2020, due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020, by the Secretary of Health and Human Services, the Director of the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration, related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19.”

The application provides a checkbox “If you were unable to operate between February 15, 2020, and the end of the Covered Period at the same level of business activity as before February 15, 2020 due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020, by the Secretary of Health and Human Services, the Director of the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19.” There is as well a certification that must be initialed, namely: “If the Borrower has checked the box for FTE Reduction Safe Harbor 1 on PPP Schedule A, the Borrower was unable to operate between February 15, 2020 and the end of the Covered Period at the same level of business activity as before February 15, 2020 due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020, by the Secretary of Health and Human Services, the Director of the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration, related to the maintenance of standards of sanitation, social distancing, or any other work or customer safety requirement related to COVID-19.”

There is a curious and as of yet unexplained distinction between the instructions and the form’s check box and initialed section: the former speaks to the borrowers “good faith,” while the application omits that qualifier. Regardless, a borrower seeking to rely on this provision needs to document its basis for relying upon this safe harbor. The application requires that the borrower maintain (although it need not be submitted with the forgiveness application) “Documentation supporting the certification, if applicable, that the Borrower was unable to operate between February 15, 2020, and the end of the Covered Period at the same level of business activity as before February 15, 2020 due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020 by the Secretary of Health and Human Services, the Director of the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration, related to the maintenance of standards of sanitation, social distancing, or any other work or customer safety requirement related to COVID-19. This documentation must include copies of the applicable requirements for each borrower location and relevant borrower financial records.”

(2) The Restoration Safe Harbor from FTEE Reductions

Another safe harbor upon which a borrower a may rely and in so doing avoid a reduction in the amount of PPP loan forgiveness exists if the borrower:

• reduced its FTEE employee levels in the period between February 15, 2020, and ending April 26, 2020; and
• the borrower then restored its FTEE employee levels by not later than December 31, 2020 to its FTEE employee levels in the Borrower’s pay period that included February 15, 2020.

Originally the deadline for restoration of FTEE levels from “not later than June 30, 2020.” After the adoption of the PPP Flexibility Act the deadline was shifted to “not later than December 31, 2020.” This expanded flexibility in restoring the borrower’s FTEE raises questions including whether it will require a delay in submitting forgiveness applications until the December 31, 2020 pay period is determined. There is some ambiguity/flexibility in the “by not later than” language, but its application has not been further explained. For example, is a restoration over one pay period sufficient?

Your Covered Period and When Can You Apply for PPP Loan Forgiveness?

The first PPP loans utilized a “covered period” of eight weeks – in that period of time the borrowed funds needed to be expended on permitted purposes, and the limitations upon forgiveness were measured (generally speaking) as of the end of or immediately after the end of that period. Under the PPP Flexibility Act, there was created an alternative twenty-four week covered period. All loans made after June 5th use this twenty-four week covered period, and borrowers with pre-existing loans may elect the longer covered period. Okay, but do you have to wait until the end of the twenty-four week period to apply for forgiveness? Assume a pre-Flexibility Act borrower who was able to fully utilize the borrowed funds in the ten weeks after the loan was made; does it need to wait another fourteen weeks to apply for forgiveness?

The answer is “no,” but there are implications of applying early. As detailed in the Interim Final Release Business Loan Program Temporary Changes; Paycheck Protection Program – Revisions to Loan Forgiveness Interim Final Rule and SBA Loan Review Procedures Interim Final Rule, applying early impacts upon the borrower’s ability to return compensation levels to the pre-borrowing levels. Recall that if compensation is reduced by more than 25%, the borrower loses, on a dollar-for-dollar basis, the ability to have the loan forgiven. That reduction will be accrued through the end of the covered period regardless of filing an early application. The IFR provides an example, namely:

A borrower is using a 24-week covered period. This borrower reduced a full-time employee’s weekly salary from $1,000 per week during the reference period to $700 per week during the covered period. The employee continued to work on a full-time basis during the covered period, with an FTE of 1.0. In this case, the first $250 (25% of $1,000) is exempted from the loan forgiveness reduction. The borrower seeking forgiveness would list $1,200 as the salary/hourly wage reduction for that employee (the extra $50 weekly reduction multiplied by 24 weeks). If the borrower applies for forgiveness before the end of the covered period, it must account for the salary reduction for the full 24-week covered period (totaling $1,200).

Conclusion

All in all, PPP loan forgiveness is a complicated process, perhaps more than it needs to be. Borrowers are advised to seek professional guidance before submitting their forgiveness applications.

That is (more than) enough for now. In forthcoming SKO Insider pieces, I will return to the Paycheck Protection Program to address accounting for your PPP loan and the process of loan forgiveness and the opportunity you will have to appeal a negative determination by your lender.

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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.

If you would like to discuss the Paycheck Protection Program, the Main Street Lending Program, or other business-assistance programs available during the COVID-19 pandemic, please contact SKO’s Jamie Brodsky (502-568-5473) or Brad Keeton (502-568-5439).

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.