The SBA unveiled its Paycheck Protection Program (PPP) Loan Forgiveness Application on Friday May 15th. While there are still some questions remaining, there is significant guidance that comes from this application.
In order to obtain forgiveness does payroll cost need to be 75% of the proceeds borrowed or of the proceeds expended?
We start off with some great news. The 75% is based upon funds expended not received. We know this based on the application itself. The section headed “Potential Forgiveness Amounts” has three separate lines and forgiveness is given to the smallest line. Let me start out with an example. Let’s assume a small business receives a $25,000 loan. Let’s further assume that payroll costs were $15,000 and rent and utilities were $3,000. The last assumption I want to make is that the small business maintained the same number of Full-time equivalent employees before and after receiving PPP funds. The reason for this is a reduction in full-time equivalent employees will reduce forgiveness and I want to keep this example as simple as possible.
The three lines under potential forgiveness would be (Line number refers to the actual form):
Line 8. Modified Total: In our example this would be $18,000 ($15,000 of payroll and $3,000 of rent and utilities).
Line 9. PPP Loan Amount: In our example this would be $25,000.
Line 10. Payroll Cost 75% Requirement (divide payroll cost by 0.75) ($15,000/.75) = $20,000. This ensures payroll costs are at least 75% of the forgiven amount.
What these three lines tell us is the actual costs ($18,000), the maximum amount of the loan that could be forgiven ($25,000, which is 100% of the loan proceeds) or $20,000. The $20,000 is the maximum amount that can be forgiven if payroll costs are $15,000. If I change the example and say that rent and utilities equal $6,000, then Line 8 goes from $18,000 to $21,000, however since non-payroll costs cannot be more than $5,000 when payroll equals $15,000, then $20,000 is the maximum that can be forgiven.
When does the 8-week clock start running?
When calculating costs, the 8-week clock begins to run the day funds are received. The form allows small business owners to use an “Alternative Payroll Covered Period” date. This date is defined below with an example.
Alternative Payroll Covered Period: For administrative convenience, Borrowers with a biweekly (or more frequent) payroll schedule may elect to calculate eligible payroll costs using the eight-week (56-day) period that begins on the first day of their first pay period following their PPP Loan Disbursement Date (the “Alternative Payroll Covered Period”). For example, if the Borrower received its PPP loan proceeds on Monday, April 20, and the first day of its first pay period following its PPP loan disbursement is Sunday, April 26, the first day of the Alternative Payroll Covered Period is April 26 and the last day of the Alternative Payroll Covered Period is Saturday, June 20.
The application does not extend this alternative covered period to rent, utilities or mortgage interest. Those must be incurred during the covered period (the 8 weeks beginning the day the small business receives PPP proceeds).
The application states all eligible costs, whether payroll or non-payroll, may be forgiven even if not paid during the covered or Alternative covered period, if they are paid before the next billing date for non-payroll expenses or next payroll date for payroll costs.
Do Schedule C filers and partners need to take actual checks to qualify for forgiveness?
It appears from the instructions that you must actually write checks or transfer funds. The instructions state:
Enter any amounts paid to owners (owner-employees, a self-employed individual, or general partners). This amount is capped at $15,385 (the eight-week equivalent of $100,000 per year) for each individual or the eight-week equivalent of their applicable compensation in 2019, whichever is lower.
Please also note that compensation is limited to 8/52 of 2019 compensation. In other words, if your 2019 Schedule C shows $52,000, then you can only pay yourself $8,000 during the 8-week covered period. No raise allowed for the boss.
The question that I still have is: Can a Schedule C filer either hire additional individuals or give bonuses to existing staff to obtain greater forgiveness. Let’s look at another example. A Schedule C filer that made $78,000 in 2019 and has 2 employees that each made $26,000 in 2019.
This individual received pay of $12,000 ($1,500 per week, or 8/52 of $78,000) and his/her employees were paid $8,000 for the 8-week period. I’m going to also assume that the small business owner received $27,000 in loan proceeds and had no rent, utilities, or mortgage interest. Forgiveness would be available for the $12,000 of Schedule C earnings and $8,000 of employee earnings but can the owner bonus $7,000 to the employees (we know owners cannot increase their own pay, but nowhere does it say employees can’t receive a bonus)? If bonuses are allowed is there a limit? Can related parties (such as a child) be hired by the small business owner?
Reduction based on Full-time Equivalent Formula
To receive full forgiveness small business owners must maintain the same number of full-time equivalent (FTE) employees as before PPP proceeds were received. A simplified method was introduced which allows workers to be classified as full-time that work 40 or more hours (1.0 FTE) in the calculation and anyone else to count as 0.5 (FTE). If small business owners prefer, they may calculate FTE by taking the average number of hours each employee worked and dividing by 40. This calculation will obviously be much more difficult (unless the owner uses a payroll services that can easily provide such a report) but may be used if it is more beneficial to the loan recipient.
There is also a reduction that can occur if pay rates decline. This could happen if a small business owner replaces employees with less expensive employees.
Definition of nonpayroll costs
The instructions define nonpayroll costs. See below:
Eligible nonpayroll costs. Nonpayroll costs eligible for forgiveness consist of:
(a) covered mortgage obligations: payments of interest (not including any prepayment or payment of principal) on any business mortgage obligation on real or personal property incurred before February 15, 2020 (“business mortgage interest payments”);
(b) covered rent obligations: business rent or lease payments pursuant to lease agreements for real or personal property in force before February 15, 2020 (“business rent or lease payments”); and
(c) covered utility payments: business payments for a service for the distribution of electricity, gas, water,
transportation, telephone, or internet access for which service began before February 15, 2020 (“business utility payments”).
An eligible nonpayroll cost must be paid during the Covered Period or incurred during the Covered Period and paid on or before the next regular billing date, even if the billing date is after the Covered Period. Eligible nonpayroll costs cannot exceed 25% of the total forgiveness amount. Count nonpayroll costs that were both paid and incurred only once.
I have been surprised that guidance on forgiveness has been slow coming out, but I believe this is only the beginning and we should see more clarifications coming out over the next few weeks.
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Hang in there and stay safe,
Jeff Skolnick, CPA, M.S. Taxation