After a lengthy delay, on May 15 the SBA published an application for Paycheck Protection Program (PPP) loan forgiveness. The application, along with the accompanying instructions, provide borrowers with much-needed clarity regarding how much of their PPP loans may be forgiven. The forgiveness application will require most borrowers to make detailed calculations to determine their forgiveness amounts. Rather than provide a detailed analysis of the PPP’s forgiveness provisions, this discussion will highlight important points from the application and its instructions.

Eligible Costs

  • With one exception (described below) a borrower will be eligible for forgiveness only for payments made and costs incurred during the eight-week period beginning when the borrower received its first PPP funds. The application refers to this period as the Coverage Period.
  • There was significant uncertainty before the issuance of the application concerning whether borrowers had to actually pay expenses during the Coverage Period to claim forgiveness. The SBA resolved that issue by stating in the instructions that a borrower may pay expenses incurred during the Coverage Period after the end of the period in the normal course of business.
  • For administrative convenience, a borrower that pays employees bi-weekly (or more frequently), may begin its eight-week Coverage Period for payroll calculations only on the date of its first pay period after it received PPP funds. The instructions refer to this as the Alternative Payroll Covered Period, and while it may be beneficial to borrowers, we will refer only to the Covered Period for ease of reading.
  • The forgiveness application retains the SBA’s earlier rule that non-payroll costs may constitute no more than 25% of the amount forgiven.
  • The application and instructions don’t address whether rental payments to a related landlord qualify for forgiveness. In the absence of further guidance, it appears that related-party rent expense is forgivable.

Limitations on Forgiveness

The CARES Act includes limits on loan forgiveness based on employees’ compensation and the borrower’s staffing. The application and instructions substantially clarify how those limits apply.

Limitation based on Compensation

  • In general, if a borrower reduces an employee’s compensation by more than 25%, it is required to reduce the amount of loan forgiveness. The limitation based on compensation only applies to employees who did not receive compensation in excess of $100,000 on an annualized basis in any quarter in 2019. 
  • The borrower compares compensation paid during the Coverage Period to compensation paid from January 1, 2020 to March 31, 2020 to measure any reduction.
  • For salaried employees, the borrower should compare annualized salaries in the Coverage Period and the January – March period. A decrease in excess of 25%, adjusted to an eight-week period, reduces the borrower’s eligible forgiveness.
  • For hourly employees, the borrower should compare the employees hourly rates rather than their total compensation during the two periods. The borrower applies the hourly decrease in excess of 25% to the employee’s average January – March hours to determine the reduction in forgiveness.
  • The application also clarifies the safe harbor rule included in the CARES Act. If an employee’s compensation decreases from February 15 to April 26, the borrower may disregard that decrease if it restores the employee’s compensation by June 30, 2020.

Limitation based on Full-Time Equivalency

  •  A borrower must reduce its loan forgiveness by the percentage decrease in its full-time equivalent (FTE) employees.
  • The instructions use a 40-hour week in calculating a borrower’s FTEs. A borrower may elect to treat employees as either 1 or .5 FTEs. An employee’s full-time equivalency can’t exceed 1.
  • The borrower compares average weekly FTEs during the Coverage Period to average weekly FTEs during one of two reference periods (at the borrower’s election). The reference periods are February 15, 2019 to June 30, 2019 or January 1, 2020 to February 15, 2020.
  • A borrower may make adjustments for reductions in FTEs for the following circumstances:

    o The borrower made a good-faith written offer to rehire an employee but the employee refused the offer
    o The borrower fired an employee for cause
    o An employee voluntarily terminated employment or requested a reduction in hours

  • A similar safe harbor applies to the FTE test. If a borrower reduced FTEs from February 15 to April 26 but restores its FTEs by June 30, it will not have to reduce its forgiveness under the FTE test.

The safe harbors under both the compensation and FTE tests are very favorable to borrowers. The test for restoration of either compensation or FTEs is only done on one date (June 30) rather than over a period, which provides ample opportunity for borrowers to make up for reductions.

Other Observations

  • The instructions include a schedule of documents that a borrower should provide with its application for forgiveness. Examples include payroll tax returns and payroll reports, receipts and cancelled checks, mortgage amortization schedules and lease documents.
  • Borrowers must maintain supporting documentation for six years after their loans are forgiven or repaid and must make those documents available to the SBA or its representatives upon request.
  • While borrowers will need to wait until the end of their Coverage Periods to apply for forgiveness, and some will wait until after June 30 to take advantage of the safe harbor rules, they can begin to compile information from the comparable periods for the payroll tests.

Although more guidance is necessary, it is now possible to estimate much more clearly how loan forgiveness will work for borrowers. If you have questions about PPP forgiveness or the application process, please contact us.

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