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New PPP Guidance Helps but Falls Short on Key Loan Forgiveness Rules

Almost weeklyTreasury, the IRS, and the SBA release guidance to help businesses understand and comply with the loan programs and tax changes enacted to mitigate economic damage from the COVID-19 pandemic. Recently, two interim final rules were released by the SBA to address some of the finer points of PPP loan forgiveness. The first set of rules covers payroll periods and other expenses during the 8-week measurement period, eligible compensation, interest, employees who refuse to work and FTE calculations. The second rule explains SBA loan review procedures.   

While the new rules pre-date the bill that was signed into law on Friday, June 5th, the clarifications are still useful.   

Highlights of New Rules 

The first set of Interim Final Rules amplifies guidance included with the forgiveness application (covered in previous article.) The most important modifications regarding loan forgiveness eligibility are in the following areas: 

Payroll Timing. Businesses with biweekly or more frequent pay cycles can elect an alternative payroll covered periodwhich is the eight-week period starting the first day of the first payroll cycle that begins after the loan funds are received. Under the original rule, the loan covered period began on the day the loan funds were disbursed, with no exceptions. Payroll costs that are incurred during the alternative period but paid after the end of the covered weeks are still eligible for forgiveness if they are paid no later than the first regular payroll date after the loan coverage period ends. 

Example based on an 8 week loan period: A borrower has a bi-weekly payroll schedule. The borrower’s regular covered period begins on June 1 and ends on July 26. The borrower’s first payroll cycle that starts in the covered period begins on June 7. The borrower may elect an alternative payroll covered period that starts on June 7 and ends 8-weeks later, on August 1. Payroll costs paid during this alternative payroll period are eligible for forgiveness, as are payroll costs incurred during this period but paid no later than the first regular payroll date occurring after August 1. 

Note that payroll both paid and accrued during the covered period is eligible for forgiveness, and a business may have a greater chance of getting an additional payroll run included in the covered period if the alternative payroll period is not usedFor example, if a business receives funds on May 1st, and the next payroll period starts on May 5ththe previous payroll would likely be paid sometime between May 1st and 5th. The funds paid for that payroll period would count towards forgiveness, as well as the payroll for wages earned during the 8 weeks beginning May 1st. 

The interim rule also clarifies that payroll costs are considered paid on the day that paychecks are distributed or the borrower originates an ACH credit transaction. Payroll costs are considered incurred on the day the employee’s pay is earned (the day the employee worked). For employees who are not performing work but are still on the borrower’s payroll, payroll costs are incurred based on the work schedule established by the borrower  

Interest Payments. Interest payments on any business mortgage obligation on real or personal property that was incurred before February 15, 2020, qualifies toward loan forgivenessPresumably, this means that the debt had to be in place before February 15, 2020The final rules make clear that prepayments of interest and payments of principal do not qualify as costs eligible for loan forgiveness.  

The interim rule is silent on payments between related parties. There does not appear to be any prohibition against adjusting the interest rate payable on debt that existed before February 15, 2020, to a fair market value interest rate. (Please note there are other tax implications to consider when visiting interest rate adjustments) 

Non-Payroll ExpensesThe interim rule explains when non-payroll costs must be paid or incurred to qualify for loan forgiveness. These costs either must be paid during the loan coverage period or incurred during the period and paid by the next billing cycle that occurs after the loan coverage period. 

Example Based on an Eight Week Coverage PeriodA borrower’s covered period begins on June 1 and ends on July 26. The borrower pays its May and June electricity bill during the covered period and pays its July electricity bill on August 10, which is the next regular billing date. The borrower may seek loan forgiveness for its May and June electricity bills because they were paid during the covered period. The borrower also may get loan forgiveness for the portion of its July bill from July 1-July 26 because it was incurred during the covered period and paid on the next regular billing date. 

The final rules do not specifically address prepaying rent for future months or paying rent in arrears during the covered period, but rather points to the overall limitation of non-payroll costs. This suggests that as long as rent is PAID during the covered period, and is not in excess of ceiling percentage of the forgiveness amount (when combined with all non-payroll costs), rent paid would be eligible for forgiveness. Similar to interest expense guidance, there is no mention of related party limitations, so adjustments of rent expense paid to related parties to fair market value may beneficial.   

Bonuses, Hazard Pay and Furloughed EmployeesThe interim rule clarifies that bonuses, hazard pay and compensation of furloughed employees are eligible for loan forgiveness. However, the employee’s total compensation including bonuses and hazard pay may not exceed $100,000 as prorated for the covered period.   

Payments to Owner-Employees and the Self-EmployedThe interim final rule provides a limitation on the amount of compensation paid to owneremployees and self-employed individuals that can be forgiven. The amount forgiven per individual cannot exceed the lesser of:  

  •  8/52 of 2019 compensation 

or 

  •  $15,385 

For owner-employees, 2019 compensation includes retirement and health insurance contributions. No additional forgiveness is provided for retirement or health insurance contributions for self-employed individuals, including Schedule C filers and general partners. Schedule C filers are capped by the amount of their owner compensation replacement, calculated based on their 2019 net profit. General partners are capped by the amount of 2019 net earnings from self-employment (with certain reductions) multiplied by 92.35%. 

The rule states that the limitation applies across all businesses of the individual, so an individual must aggregate compensation from all businesses owned when applying the cap. The effect of this rule is that only $15,385 of owner compensation can be forgiven from  ALL businesses owned.  

This new rule clarification may have a negative impact on businesses taxed as S Corps, C Corps or partnerships where the owners may not have taken a full year of compensation or had limited earnings in 2019. 

No Double Penalty for Reducing Hours. If an employer reduces its employees’ salaries or wages in excess of 25%, the law requires a reduction in the loan forgiveness amount. For purposes of determining the limitation on loan forgiveness, the rule clarifies that a reduction in compensation related to a reduction in hours will not be counted as a reduction in compensation, eliminating the potential to be penalized twice on both the FTE calculation and the reduced salary calculation. 

FTE Calculations and Special Rules 

Borrowers seeking forgiveness must document their average number of employees during the covered period and a reference period to determine if they have maintained payroll at the required levelThe interim rule defines full-time equivalent (FTE) as 40 hours of work and includes two methods for calculating FTEs for employees who do not work full time. For method one, the borrower may calculate the average number of hours a part-time employee was paid per week during the covered period. For example, if an employee was paid for 30 hours per week on average, the employee could be considered an FTE employee of 0.75. Under the second method, borrowers may elect to use a full-time equivalency of 0.5 for each part-time employee.  

Employees Who Refuse to be Rehired Employers can exclude from loan forgiveness calculations employees who refuse to be rehired if the following requirements are met: 

(i) the borrower made a good faith, written offer to rehire the employee or to restore reduced hours during the covered period or the alternative payroll covered period;  

(ii) the offer was for the same salary or wages and same number of hours earned by the employee in the last pay period prior to the separation or reduction in hours;  

(iii) the offer was rejected by the employee; 

(iv) the borrower maintains records documenting the offer and its rejection; and 

(v) the borrower informs the state unemployment insurance office of the employee’s rejected offer of reemployment within 30 days of the rejection. 

In addition, a borrower will not be penalized with FTE reductions for employees who are fired for cause, voluntarily resign, or voluntarily take a reduction in hours.    

RehiringEmployers can restore loan forgiveness and avoid a reduction in FTEs if a borrower rehires employees and restores salary and wage levels. The deadline for rehiring was extended to December 31 as part of the Bill approved by congress on June 3rd, 2020. This rule offers borrowers an important opportunity to cure reductions in employees that occurred earlier and regain loan forgiveness.  

Loan Review Procedures 

The second interim final rule establishes loan review procedures and borrower-lender responsibilities. Some key points are these: 

  • The SBA says it will review any PPP loan, in its discretion. Borrowers should take this as a warning that all loans are subject to review, not just loans over $2 million 
  • Lenders must issue a decision to SBA on loan forgiveness not later than 60 days after receipt of a complete loan forgiveness application from the borrower.
  • The borrower must retain PPP documentation for six years after the loan is forgiven or paid in full. 
  • If the SBA determines the borrower is ineligible for the PPP loan, the lender must deny the loan forgiveness application and may seek repayment of the outstanding PPP loan balance. The borrower may appeal this determination. The SBA intends to issue a separate rule addressing the appeals process. 

Conclusion 

Treasury characterized its final interim rule on PPP loan forgiveness in this way. “By providing a high degree of certainty to PPP borrowers through this interim final rule, PPP borrowers will be able to take immediate steps to maximize their loan forgiveness amounts, for example, by either rehiring employees or not laying off employees during the covered period.”  

Given the many time limitations, borrowers need to understand their options regarding loan forgivenessContact the PPP team at Frazier & Deeter to get started.

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