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Business Loan Program Temporary Changes; Paycheck Protection Program as Amended by Economic Aid Act

The Payroll Protection Program (PPP) became law as part of the CARES Act on March 27, 2020. Once it became law the SBA and/or the Treasury published 25 interim final rules providing guidance. The Economic Aid Act became law on December 27, 2020 and on January 6, 2021 the first interim rule was published by the SBA and Treasury. I am stating this history in order to explain why I am sure there will be more on both the First Draw PPP program and the PPP Second Draw program (which I cover later in this article).

This latest interim rule is not intended to make changes but in order to consolidate the many changes that have occurred since the program was first implemented.

General

Congress authorized a total of $806.45 billion for the First Draw PPP and the Second Draw programs.

The new law extends the time to apply for a PPP loan to March 31, 2021.

First Draw PPP

Generally, any business that employs less than 500 employees qualifies. This includes self-employed individuals, nonprofit organizations, veterans organizations, and tribal business concerns. The law specifically includes sole proprietors, independent contractors, and eligible self-employed individuals. You must have been in business as of February 15, 2020.

The maximum amount of the loan is the lesser of the average total monthly payments by the applicant for payroll costs incurred multiplied by 2.5 or $10 million. The borrower has the option to use payroll costs of 2019, 2020 or during the 1-year period before the date on which the loan is made. There are some special rules for seasonal employers, which I do not cover in this writing.

Stated more simply, an employer calculates their average monthly payroll costs and multiplies that figure by 2.5 and compares that to $10,000,000, and whichever is less will be the maximum amount. Let’s say a company determines their monthly payroll costs to be $40,000. The maximum loan allowed is $40,000 multiplied by 2.5, or $100,000. $100,000 is far less than $10,000,000 and would, therefore, be the maximum. 

Payroll Costs

One of the biggest keys is determining the definition of payroll costs. These are defined in the law as payments of salary, wages, commission, tip or equivalent, payment for vacation, parental, family, medical, or sick leave, allowance for dismissal or separation, payment for the provisions of employee benefits consisting of group healthcare or group life, disability, vision, or dental insurance, including insurance premiums, retirement benefits, state or local tax assessed on employee compensation, payments to a sole proprietor or independent contractor that is a wage, commission, income, net earnings from self-employment of similar compensation that does not exceed $100,000 in 1 year. Farmers and ranchers are allowed to use gross income of their Schedule F for 2019 or 2020, as opposed to net income.

There are some things that are not allowed as payroll costs, and they include annual salary of an employee in excess of $100,000, which must be prorated. In other words, if we look at a 4-month window, the prorated amount of a maximum $100,000 salary would be $33,333. Also excluded are federal payroll taxes, withholding, and railroad retirement tax as well as payments to individuals whose principal place of residence is outside the United States. Additionally, qualified sick and family leave wages for which a credit was taken under the Families First Coronavirus Response Act.

You must provide proof of payroll by furnishing Forms 941 (or other tax forms containing similar information), state unemployment insurance forms along with evidence of any retirement and health insurance contributions. A payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided as evidence that you were in business as of February 15, 2020.

Self-employed individuals must provide Form Schedule C for either 2019 or 2020 as well as a 2020 invoice or bank statement to establish you were in business as of February 15, 2020. Self-employed individuals will also have to provide Forms 941, state unemployment insurance forms and evidence of retirement or health insurance contributions if they have any employees.

Farmers and ranchers furnish the same information as self-employed individuals except they use Schedule F instead of Schedule C. Keep in mind they can use the gross receipts, not the net profit (self-employed individuals must use net profit) plus the same expenses for employees as listed above. If farmers and ranchers have employees, they must provide the same information as mentioned above.

Partnerships would provide the same information as above for employees (Forms 941, state unemployment insurance forms and retirement and health insurance contributions). Additionally, they add the net earnings from self-employment reduced by section 179 expenses claimed, unreimbursed partnerships expenses claimed and depletion on oil and gas properties multiplied by 92.35%, up to a maximum of $100,000 per partner. Partnerships must provide Form 1065 (including K-1s) in addition to the required documents for employees.

The loan proceeds are allowed to be used for payroll costs (which we already defined), interest on any mortgage obligation, rent, utilities, and interest on any other debt obligations incurred before the February 15, 2020.

Additional expenses allowed for loans obtained in 2021

The categories I show below are directly from the new law. I know these paragraphs contain a fair amount of legalese, however I included them in their entirety because they also offer many examples which I believe is helpful.

Covered operations expenditures (payments for any business software or cloud computing service that facilitates business operations, product or service delivery, the processing, payment, or tracking of payroll expenses, human resources, sales and billing functions, or accounting or tracking of supplies, inventory, records, and expenses);

Covered property damage costs (costs related to property damage and vandalism or looting due to public disturbances that occurred during 2020 that was not covered by insurance or other compensation);

Covered supplier costs (expenditures made by a borrower to a supplier of goods for the supply of goods that—(A) are essential to the operations of the borrower at the time at which the expenditure is made; and (B) is made pursuant to a contract, order, or purchase order—(i) in effect at any time before the covered period with respect to the applicable covered loan; or (ii) with respect to perishable goods, in effect before or at any time during the covered period with respect to the applicable covered loan); and

Covered worker protection expenditures ((A) operating or a capital expenditures to facilitate the adaptation of the business activities of an entity to comply with requirements established or guidance issued by the Department of Health and Human Services, the Centers for Disease Control, or the Occupational Safety and Health Administration, or any equivalent requirements established or guidance issued by a State or local government, during the period beginning on March 1, 2020 and ending the date on which the national emergency with respect to the COVID–19 expires related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID–19; (B) such expenditures may include—(i) the purchase, maintenance, or renovation of assets that create or expand—(I) a drive-through window facility; (II) an indoor, outdoor, or combined air or air pressure ventilation or filtration system; (III) a physical barrier such as a sneeze guard; (IV) an expansion of additional indoor, outdoor, or combined business space; (V) an onsite or offsite health screening capability; or (VI) other assets relating to the compliance with the requirements or guidance described in subparagraph (A), as determined by the Administrator in consultation with the Secretary of Health and Human Services and the Secretary of Labor; and (ii) the purchase of—(I) covered materials described in section 328.103(a) of title 44, Code of Federal Regulations, or any successor regulation; (II) particulate filtering facepiece respirators approved by the National Institute for Occupational Safety and Health, including those approved only for emergency use authorization; or (III) other kinds of personal protective equipment, as determined by the Administrator in consultation with the Secretary of Health and Human Services and the Secretary of Labor; and (C) such expenditures do not include residential real property or intangible property).

At least 60% of expenditures must be for payroll costs.

Other Loan Provisions

• These loans are made without any personal guarantees of shareholders, members, or partners.
• There is no collateral required.
• No SBA fees
• No requirement to prove that the small business is unable to obtain credit elsewhere.
• The interest rate will be 1%

Borrower Certifications

The major certifications are:

• Applicant was in operation on February 15, 2020.
• That the uncertainty of current economic conditions makes the loan request necessary to support the ongoing operations of the eligible recipient; There is a safe harbor rule that states PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan in good faith.
• Acknowledging that funds will be used to retain workers and maintain payroll or make mortgage interest payments, rent, utility, covered operations expenditures, covered supplier costs, and covered worker protection expenditures.
• That the eligible recipient does not have an application pending for a loan under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan. 
• When applying for loan forgiveness at least 60% of the loan proceeds were used for payroll costs.
• That the eligible recipient has not received amounts under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan. In other words, you cannot obtain two PPP loans. There is a Second draw loan allowed (covered later in this writing), which is not the same as two PPP loans.
• Applicant has not and will not receive a Shuttered Venue Operation grant from SBA.
• The fact that information provided is true and accurate and making a false statement is punishable under the law by imprisonment of not more than five years and a fine of up to $250,000.

Loan Forgiveness

This is probably the coolest part of the Paycheck protection program. The amount of the loan that will be forgiven is the actual amount spent during the 8-week or 24-week covered period following the loan origination date for payroll costs (defined above), interest on any covered mortgage obligation, rent, utilities, covered operations expenditures, covered supplier costs, and covered worker protection expenditures. The 8-week covered period only applies to loans obtained before June 5, 2020. All loans obtained subsequent to June 4, 2020 use a 24-week covered period. Borrowers who secured their loans before June 5, 2020 have the option of an 8-week or 24-week covered period. This election is made on the application for forgiveness.

The amount of loan forgiven may not exceed the principal borrowed. There are reductions to the forgiveness amount if the employer reduces the average number of full-time employees. There is also a reduction of forgiveness if there is a substantial reduction (in excess of 25%) in compensation of an employee. These rules do not apply to loans of $50,000 or less.

The SBA had stated that EIDL advances received by a borrower were to be deducted from the loan forgiveness amount. This provision has been repealed.

Loan forgiveness must be applied for within 10 months after the end of the covered period.

Borrowers must submit documentation to the lender when seeking forgiveness. The lender has 60 days to issue its decision on forgiveness.

Simplified Loan Forgiveness for loans of $150,000 or less

Borrowers will sign and submit a one-page form with the loan amount and number of employees retained.

Estimate loan amount spent on payroll.

Attest to complying with PPP requirements and record retention.

While no documentation is required with the application, borrowers must retain records of employment records, for the 4-year period following submission of loan forgiveness application and 3-years for other eligible expenses. The SBA has the right to audit these records.

Tax Impact of Forgiven Loans

Normally when a taxpayer receives cancellation of a debt, it is considered taxable income; however, these loans are considered an exception and are not taxable income!

In addition, any expenses paid with forgiven PPP funds are deductible.

There is an issue to be aware of for Partnerships (including LLCs that file as partnerships) and S corporations (including LLCs that file as S corporations). In order to deduct losses a taxpayer must have basis in the entity. Although forgiven PPP funds are not considered taxable income, they do increase the basis of a taxpayer. The issue is while companies incurred PPP expenses in 2020 if they do not receive forgiveness of the loan until 2021, then it is not considered income until 2021 and they may not be able to deduct losses in 2020. In that case the loss would be suspended in 2020 and taken against 2021 income.

For example, let’s look at an S corporation with a single shareholder. We’ll assume the shareholder has a $0 basis at the beginning of 2020. We’ll further assume that the S corporation received $200,000 in PPP funds and has a $200,000 loss and has not received forgiveness of its PPP loan in 2020 but will in 2021. The last assumption is the $200,000 loss occurred because the corporation was at a break even and the $200,000 loss was generated by using PPP funds to pay for expenses. Since the $200,000 loan is not forgiven in 2020 the shareholder does not have basis to deduct the loss. The $200,000 loss would be suspended and carried to 2021.

Loan Provisions for Loans not Fully Forgiven.

Any portion of a loan not fully forgiven will have an interest rate of 1% and a maturity date of five years. Borrowers that obtained a loan before June 5, 2020 will have signed a loan agreement that states there is a two-year maturity. These borrowers would have to amend their loan agreement with the lender in order to take advantage of the five-year maturity. For most borrowers this should not be a major problem as most if not all loan proceeds will typically be forgiven if funds were used for eligible expenses.

Other Provision

As I stated earlier there were many changes in the PPP rules. If a borrower received less than the maximum amount of their loan because of the changing provisions or if they returned all or part of their original loans, then they may reapply for the difference if thy have not received forgiveness.

PAYCHECK PROTECTION PROGRAM SECOND DRAW LOANS

This interim rule addresses the implementation of the Economic Aid to Hard-Hit Businesses, Nonprofits and Venues Act (the Economic Aid Act).

The purpose of this program is to “provide assistance to individuals and businesses that have been financially impacted by the ongoing coronavirus pandemic.”

These loans must be applied for by March 31, 2021.

Loan Provisions

Second Draw PPP Loans are generally subject to the same terms as First Draw PPP loans. I will now discuss the differences between these two types of loans.

Eligibility

• While First Draw loans allowed businesses that employ less than 500 employees the second draw program reduces this figure to 300 employees.
• Borrower must have received a First Draw Loan and have used or will use the full amount of the initial PPP loan for authorized purposes before the disbursement of the Second Draw PPP Loan.
• The borrower must have experienced a revenue reduction of at least 25% in one of the quarters of 2020 when compared to the 2019 corresponding quarter. The example given in the rule states a borrower with gross receipts of $50,000 in the second quarter of 2019 and $30,000 in the second quarter of 2020 has experienced a revenue reduction of 40% and is therefore eligible. A business may also choose to compare all of 2020 against 2019 to show a 25% reduction. This threshold is more difficult to reach because you only need one quarter of at least a 25% reduction, however some entities do not prepare financial statements and if the entire year is down by at least 25% the entity can simply supply its tax returns as proof. If the borrower was in business for only part of 2019, then there are some different rules used to measure the 25% decline.

The ruling states forgiveness of a First Draw PPP loan is excluded from the gross receipts calculation.

Maximum Loan Amount

The maximum amount of the loan is the lesser of the average total monthly payments by the applicant for payroll costs incurred multiplied by 2.5 or $2 million. (Remember that First Draw PPP loans could be up to $10 million.) The borrower has the option to use payroll costs of 2019, 2020 or during the 1-year period before the date on which the loan is made. There are some special rules for seasonal employers, which I do not cover in this writing.

There is an exception for hotels (except Casinos), motels and restaurants. These entities have a maximum of the lower of 3.5 times monthly payroll or $2,000,000.

The reason for the additional payroll of hotels, motels and restaurants is because these groups of businesses were some of the hardest hit economically by the pandemic.

Application and documentation requirements

While the provisions are basically the same as First Draw PPP loans there is no additional documentation required if the applicant used calendar 2019 figures to determine its First Draw PPP loan amount, uses the 2019 figures for the Second Draw amount and has the same lender for both loans.

For loans greater than $150,000 documentation of the 25% revenue reduction must be provided. Acceptable forms of documentation include annual tax forms, quarterly financial statements, or bank statements.

For loans of $150,000 or less this documentation is not required until on or before the date the borrower applies for forgiveness.

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Hang in there and stay safe,

Jeff Skolnick, CPA, M.S. Taxation