On Tuesday, August 4th, 2020, the SBA and Department of Treasury issued a list of Frequently Asked Questions (FAQs) regarding forgiveness of Payroll Protection Program (PPP) loans. I have attached a complete copy of the FAQs to this email, and I will now highlight the contents.
The first section covers General loan Forgiveness FAQs. The questions covered in this area state that sole proprietors, independent contractors, and self-employed individuals with no employees file form 3508EZ to obtain forgiveness. They also state that E-signatures may be used and a borrower that applies for forgiveness in a timely manner (within 10 months of the completion of the covered period, either 8 or 24 weeks), is not required to make any payments until the forgiveness amount is remitted to the lender by the SBA. In other words when the business is informed of any unforgiven loan proceeds. Interest accrues on any unforgiven portion of the loan from the day the proceeds were originally received.
Keep in mind; I am advising my clients not to run to forgiveness at this time.
The second section covers Loan Forgiveness Payroll Costs FAQs. The first few questions cover timing of expenses. My belief is with the 24-week covered period option; most small businesses will be able to obtain total forgiveness. You can refer to questions 1 through 3 in this section of the FAQs for more detail.
Questions 4 through 7 highlight that gross, and not net, payroll should be used when calculating compensation for forgiveness. That salaries and wages can include tips, commissions, bonuses, and hazard pay. The only limit is each employee is limited to $100,000 on an annualized basis. Also covered are both health care and retirement benefits. The questions state that only costs incurred during the covered period (8 or 24 weeks) may be counted. For group health benefits, this figure is easily obtained from paid bills. Retirement limits may have to be limited to either 8/52 or 24/52 of the 2019 contribution, as most companies will not know their 2020 contribution until the end of the year. I expect to see more guidance on retirement benefits going forward.
Question 8 discusses owner compensation. The law was originally written to allow a maximum of 8/52 of 2019 compensation for owner employees. This amount is generally found on line 31 of Schedule C for sole proprietors and independent contractors. For general partners it is their self-employment taxable income form line 14a of their partnership K-1 reduced by any section 179 expense shown on line 12 of the K-1.The maximum allowable payroll is $100,000 and therefore the maximum allowed was 8/52, or $15,385. The PPP Flexibility Act changed the maximum to 2.5 times the monthly payroll cost. If we use $100,000, then the maximum amount becomes $20,833. This assumes that the small business owner has selected the expanded 24-week covered period. If the owner selects the 8-week period, then only $15,385 is allowed. Businesses can choose either an 8-week or 24-week covered period. I suggest to any Schedule C filer that they take the expanded 24-week covered period and use 100% for payroll. The IRS has ruled that since PPP funds forgiven are not considered taxable, then expenses paid with those funds are not deductible. This may change, however, if the law is not changed, then I would rather see the Schedule C filer use all the PPP for his/her own compensation because that is not deductible on a Schedule C anyway. Let’s take an example of a sole proprietor that capped themself at $100,000 and therefore borrowed $20,833. If the sole proprietor were to use $15,385 as compensation and the remaining $5,448 for rent and the IRS ruling is not changed, then the $5,448 is not deductible. If the sole proprietor elects the 24-week covered period and takes all $20,833 as compensation, then he/she still gets to deduct rent expense.
Question 8 also states that a C corporation shareholder receives not only the compensation as outlined above but also employer contributions on their health insurance and employer contributions to their retirement plans capped at 2.5/12 of the 2019 employer retirement plan contribution.
S corporation shareholders with at least 2% ownership in the corporation are not allowed health benefits. For S corporation shareholders that own at least 2% of the stock, health benefits are included in their W-2 wages and wages are limited to the same amounts as a sole proprietor discussed above. Employer contributions to their retirement plans are capped at 2.5/12 of the 2019 employer retirement plan contribution.
.
Lastly, LLCs are considered disregarded entities. They are legal entities only. For taxation purposes they are treated as either sole proprietorships, partnerships, or S corporations.
The third section covers Loan Forgiveness Nonpayroll Costs FAQs. The first few questions in this section again have to do with timing of nonpayroll expenses and the fact that the covered begins for nonpayroll costs on the day PPP funds were received. Payroll is allowed an Alternative payroll covered period to coincide with a business’s regularly scheduled payroll if the business pays bi-weekly or more frequently. Nonpayroll costs are not eligible for this alternative calculation. This section also appears to clarify that gasoline for automobiles is not considered a utility. It had appeared from an earlier Interim Rule that this would be allowable.
The fourth and final section discusses Loan Forgiveness Reductions FAQs. This section outlines that businesses have until December 31, 2020 to restore Full Time Equivalent (FTE) employees to their February 15, 2020 levels. Below is the answer to what happens if a business attempts to rehire individuals but are turned down. It is the answer to Question 1 of this section of FAQs.
“In calculating its loan forgiveness amount, a borrower may exclude any reduction in FTE employees if the borrower is able to document in good faith the following: (1) an inability to rehire individuals who were employees of the borrower on February 15, 2020 and (2) an inability to hire similarly qualified individuals for unfilled positions on or before December 31, 2020. Borrowers are required to inform the applicable state unemployment insurance office of any employee’s rejected rehire offer within 30 days of the employee’s rejection of the offer. The documents that borrowers should maintain to show compliance with this exemption include the written offer to rehire an individual, a written record of the offer’s rejection, and a written record of efforts to hire a similarly qualified individual.”
The FAQs also covers wage reductions in excess of 25% also result in a reduction to forgiveness.
I want to start this article off by discussing why I believe it makes sense for almost all small businesses that received PPP funds to hold off just a bit on applying for forgiveness. Let’s start at the beginning. A Payroll Protection Program Loan is an SBA loan. To further clarify it is also considered an Economic Injury Disaster Loan (EIDL). All EIDL loans are SBA loans, however, not all SBA loans are EIDL loans. Also, all PPP loans are EIDL loans, but not all EIDL loans are PPP loans. In other words, PPP loans are a subset of EIDL loans which are a subset of SBA loans. When individuals borrow money from the SBA, it is generally treated as any other loan. The loan is expected to be repaid. The PPP loans contain a specific provision which allows these loans to be forgiven if certain conditions are met.
There are a number of reasons why I believe small business owners should wait on PPP forgiveness.
As with the rollout of the PPP, nobody has ever been involved in this program before. If you remember the CARES Act was passed on March 27, 2020 and the PPP started the following week, April 3rd. Many lenders were not ready on day 1 and the process was complicated and confusing during the first 6 or 7 weeks while rules were constantly changing, and lenders and the SBA were still figuring it all out. If you applied for a PPP loan before approximately May 15th and after May 15th you had far different experiences. Once the system had more defined rules and the lending institutions and SBA had some experience, the process was much smoother.
It is my belief that the same thing will occur on the forgiveness end. There was a forgiveness form released. Before the form was even used it was replaced by 2 more forms (an EZ short form and a more simplified long form). My feeling here is that there can still be changes made to these forms as well. Even if no changes are made none of these forms have been processed to date.
I believe that almost all borrowers should utilize the 24-week, compared to the 8-week covered period for forgiveness. It allows more owner’s compensation and also it allows businesses that may not have been able to restore their full payroll to use payroll and costs for up to 24 weeks. It also allows nonpayroll costs (rent, utilities, or mortgage interest) to be used for 24 weeks, instead of 8 weeks.
There is no benefit to being forgiven in August vs. being forgiven in November or December. The only thing that happens if borrowers wait and have a portion of the loan not forgiven is that interest has accrued at the rate of 1% over that time period. It is my feeling that the Payroll Protection Program Flexibility Act passed on June 5th allows almost all businesses to achieve total forgiveness which makes the interest a moot point. Even if there is a portion not forgiven, it should be exceedingly small and 1% interest for a few months will be negligible.
Lastly, there is currently talk of forgiving all loans under $150k. It may be as simple as borrowers certifying on a 1-page form that the PPP funds were used for their intended purpose. The push for this legislation is because loans under $150k account for 86% of the total loans, but only 26% of the total proceeds. This would allow the SBA and lenders to focus their resources on the remaining 14% of borrowers that are responsible for 74% of the borrowed funds. If this legislation were to pass this would simplify the process for most borrowers.
Join me, Every Monday at 12:30pm (EST) here: https://www.facebook.com/jeffcpaworld/
If you’d like to book an appointment with me, please click on the link below:
Hang in there and stay safe,
Jeff Skolnick, CPA, M.S. Taxation