Loan Forgiveness Under the Paycheck Protection Program

By Brian Bernhardt

As part of the CARES Act signed into law on March 27, 2020, Congress enacted the Paycheck Protection Program (the “PPP”).  The PPP is designed to, in general, provide small businesses with a short term loan (a “PPP Loan”) equal to two and a half months of payroll.  For general rules governing the PPP and PPP Loans, please see Forrest Firm blog articles here and here.  

Section 1106 of the CARES Act provides for the forgiveness of these PPP Loans in certain circumstances by converting the PPP Loans into grants.  Unfortunately, the Small Business Administration (the “SBA”) has not issued any formal guidance, or even an informal Frequently Asked Questions and Answers, addressing the details surrounding PPP Loan forgiveness.  On Friday, May 15, 2020, however, the SBA issued the Paycheck Protection Program Loan Forgiveness Application (the “Application”), which includes instructions, definitions, calculation forms, schedules, worksheets, and documentation requirements. 

Treasury Secretary Mnuchin has indicated that he does not believe further guidance is necessary regarding PPP Loan forgiveness. As a result, it is possible that the Application provides all the details and information businesses will receive in order to determine how much of their PPP Loan will be forgiven as a grant.  If that is the case, then any business hoping to maximize its forgiveness must understand the Application and how it interacts with the PPP.

When do PPP Loan Proceeds Need to be Spent in Order to be Eligible for Forgiveness?

The Cares Act provides that the amount of the PPP Loan that can be forgiven is the sum of certain costs incurred and payments made during the eight weeks (56 days) immediately following disbursement of the PPP Loan to the borrower (the “Covered Period”).  The Application explains that the first day of the Covered Period is the same date that the borrower receives its PPP Loan proceeds; thus, if the PPP Loan proceeds are disbursed on April 20, the first day of the Covered Period is April 20 and the last day of the Covered Period is June 14.  However, if the PPP Loan proceeds are disbursed on May 11, the first day of the Covered Period is May 11 and the last day of the Covered Period will actually be July 11 – even though, for other purposes, such as determining whether laid-off employees have been hired back, the period for making such a determination under the CARES Act ends June 30. 

Unlike the text of the CARES Act, the Application creates an alternative covered period with respect to payroll costs (the “Alternative Payroll Covered Period”).  The SBA explains that it created the Alternative Payroll Covered Period for the administrative convenience of borrowers with a biweekly (or more frequent) payroll schedule.  These borrowers may elect to calculate their payroll costs (but not operating costs) using the eight week (56 day) period that begins on the first day of their first pay period after the date of the PPP Loan disbursement.  For example, if the PPP Loan proceeds are disbursed on April 20, and the first day of the borrower’s first pay period following disbursement of the PPP Loan is April 26, then the first day of the Alternative Payroll Covered Period is April 26 and the last day of the Alternative Payroll Covered Period is June 20.

The Application also answers a question that the CARES Act left open. The CARES Act provides that the amount of the PPP Loan that can be forgiven is the sum of certain “costs incurred and payments made” during the Covered Period (or, as may be applicable, the Alternative Payroll Covered Period).  It was unclear whether that provision in the CARES Act meant that the relevant costs needed to be both incurred and paid during those time periods to be eligible for forgiveness, or whether costs incurred during those time periods would be eligible for forgiveness and also payments made during those time periods would be eligible for forgiveness.  The Application comes down on the later more expansive disjunctive use of the phrase: costs incurred during those time periods are eligible for forgiveness and also payments made during those time periods are eligible for forgiveness (though each payroll or operating item may only be forgiven once, even though it may be both paid and incurred).  Thus, for example, costs incurred prior to disbursement of the PPP Loan, but on or after February 15 and paid during the Covered Period or, as may be applicable, the Alternative Covered Period, are subject to forgiveness.

What Type of Expenses Create Loan Forgiveness for PPP Loan Proceeds?

There are four types of expenses eligible for transforming PPP Loan proceeds into forgivable grants if the costs for the expenses are incurred and payments made during the Covered Period (or, in the Application, the Alternative Payroll Covered Period).  They are:

  1. Payroll Costs.  Borrowers are generally eligible for forgiveness for the payroll costs incurred and payroll costs paid during the Covered Period (or, if applicable, the Alternative Payroll Covered Period).  
    • 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 that the employee’s pay is earned.  
    • Payroll costs incurred but not paid during the Borrower’s last pay period of the Covered Period (or, as may be applicable, the Alternative Payroll Covered Period) are eligible for forgiveness if they are paid on or before the next regular payroll date. Otherwise, payroll costs must be paid during the Covered Period (or, if applicable, the Payroll Covered Period).  
    • For each individual employee, the total amount of cash compensation eligible for forgiveness may not exceed an annual salary of $100,000, as prorated for the Covered Period (or, as may be applicable, the Alternative Payroll Covered Period), which would be $15,385.  
    • Count payroll costs that were both paid and incurred only once. 
    • Payroll costs must be 75% of the amount forgiven.
    • Notably, the Application provides a line item for including in payroll costs “any amounts paid to owners (owner-employees, a self-employed individual, or general partners)”, capping this amount at the lower of (a) $15,385 for each individual (the eight week equivalent of $100,000 per year) or (b) the eight-week equivalent of each individual’s compensation in 2019. Since this Application does not require that this amount be paid as “compensation,” apparently this line item means that payments to partners and/or guaranteed payments are included in payroll costs.  Also, since these payments are limited to the lower of $15,385 or the eight-week equivalent of their 2019 compensation, owners cannot increase their compensation during the Covered Period (or, as may be applicable, the Alternative Payroll Covered Period) to maximize forgiveness.
  2. Mortgage Interest Payments.  Payments of interest (not including any prepayment or payment of principal) on any business mortgage obligation on real or personal property where the indebtedness was originally incurred prior to February 15, 2020.  
  3. Rent Payments.  Business rent or lease payments related to lease agreements for real or personal property which were in force before February 15, 2020.  Notably, there is no guidance, as of yet, regarding prepayments of covered rent; since the rules for forgiveness of mortgage interest payments explicitly exclude any prepayment or payment of principal, and neither the statute nor any other guidance address prepayments of rent, on first glance it appears that prepayments of rent are allowed for purposes of computing the amount of a PPP Loan that should be forgiven; however, when the Application describes the type of documentation needed to prove the rent payments made, one of the two options is an account statement from the lessor from February 2020 through one month after the end of the Covered Period, which indicates that, at most, one prepayment of rent is eligible for loan forgiveness.
  4. Utility Payments.  Business payments for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for service which began before February 15, 2020.  Again, there is no guidance, as of yet, regarding prepayments of covered utilities; but when the Application describes the type of documentation needed to prove the utility payments made it requires the production of invoices, which certainly implies that prepayments of utilities are not eligible for forgiveness, since a borrower would not be able to provide invoices from utility companies that have not yet been created.

Calculating the Base Level Loan Forgiveness Allowed

At its most basic, a borrower will calculate the initial base amount of the PPP Loan which it may have forgiven by adding together (a) the Payroll Costs incurred and paid during the Covered Period or, as may be applicable, the Alternative Payroll Covered Period, and (b) the mortgage interest payments, rent payments, and utility payments incurred and paid during the Covered Period.

Keep in mind that the amount of the PPP Loan forgiven may not exceed the principal amount of the PPP Loan and the maximum amount which can be forgiven is $10 million.  Further, 75% of the costs incurred and paid during the Covered Period or, as may be applicable, the Alternative Payroll Covered Period, must be payroll costs.  Borrowers may choose not to include some of the non-payroll costs in their calculation in order to make sure they comply with that 75% threshold.

Reduction in Amount Allowed Forgiven Based on Reduction of Salary or Hourly Wages

The CARES Act requires borrowers to reduce the amount of the PPP Loan which may be forgiven if, under certain circumstances, the salary or hourly wages of the borrower’s employees are reduced.  The Application adds further details to this reduction calculation and process.

The amount of the PPP Loan which may be forgiven is reduced if the employer reduces an employee’s salary or hourly wages during the Covered Period or the Alternative Payroll Covered Period by more than 25% compared to the first quarter of 2020.  Note that this comparison is done on an employee by employee basis and not based on overall payroll.  A borrower can avoid this reduction, however, if the employer meets a safe harbor – eliminating the 25% reduction of salary or hourly wages by June 30, 2020.

Suffice it to say, the math calculations used to determine (1) if the PPP Loan forgiveness should be reduced, (2) if so, whether the safe harbor applies, and (3) if the safe harbor does not apply, the amount by which the PPP Loan forgiveness should be reduced, is lengthy, complicated, and burdensome.  It is beyond the scope of this blog post, but we anticipate that we will address this computation in a future blog post.

Reduction in Amount Allowed Forgiven Based on Reduction of FTE Employees

The CARES Act requires borrowers to reduce the amount of the PPP Loan which may be forgiven if, under certain circumstances, the number of the borrower’s full-time equivalent employees is reduced.  The Application adds further details to this reduction calculation and process.

First, borrowers need to understand how to determine how many FTE employees they have at any given time.  The Application provides two methods.  The detailed (and more complicated) method is to determine, for each employee, the average number of hours the employee was paid per week (not worked per week, which may provide a benefit to borrowers that paid employees who did not work), divide by 40, and round the total to the nearest tenth. The maximum for each employee is capped at 1.0, which indicates a single FTE employee.  The second, and more simplified method, simply treats each employee who work 40 hours or more per week as a single FTE employee and each employee who works less than 40 hours per week as half of an FTE employee.  Borrowers will need to compare the first method against the simplified method to determine which is more beneficial for their situation. 

Under the Application, the amount by which a borrower will reduce the amount of the PPP Loan which may be forgiven is expressed as a fraction.  The numerator of the fraction (the top number) is the average number of FTE employees per week employed by the borrower during the Covered Period or the Alternative Payroll Covered Period (whichever period they used to calculate the base amount of the PPP Loan which it may have forgiven).  The denominator of the fraction (the bottom number) will be one of the following, at the election of the borrower:

  1. The average number of FTE employees per month employed by the borrower between February 15, 2019 and June 30, 2019;
  2. The average number of FTE employees per month employed by the borrower from January 1, 2020 to February 29, 2020; or
  3. For seasonal employers, either of the above or any consecutive 12 week period between May 1, 2019 and September 15, 2019.

Again, borrowers will need to compare the options for the denominator to determine which is more beneficial for their situation.  For instance, if the borrower employed an average of 100 FTE employees per week during the Covered Period, an average of 90 FTE employees between February 15, 2019 and June 30, 2019, and an average of 125 employees between January 1, 2020 to February 29, 2020, then the employer would choose between fractions of 100/90 and 100/125.  In that case, the employer would choose for its denominator the February 15, 2019 to June 30, 2019 period (a fraction of 100/90), which results in no reduction in PPP Loan forgiveness rather than the January 1, 2020 to February 29, 2020 period (a fraction of 100/125), which would reduce the PPP Loan forgiveness by 20% (100/125 = 80%, resulting in a reduction of 20% of the FTE employees).

There are, however, four exceptions to this calculation.  If these exceptions apply, then the employees to whom the exception applies will be excluded from the denominator of the fraction for calculating this reduction in PPP Loan forgiveness. The four exceptions are:

  1. Rejected Good Faith Offers.  If the employer made a good-faith, written offer to rehire an employee during the Covered Period or the Alternative Payroll Covered Period which was rejected by the employee, then that employee will be excluded from the denominator of the fraction.
  2. Fired for Cause.  If, during the Covered Period or the Alternative Payroll Covered Period an employee was fired for cause, then that employee will be excluded from the denominator of the fraction.
  3. Voluntary Resignation.  If, during the Covered Period or the Alternative Payroll Covered Period an employee voluntarily resigned, then that employee will be excluded from the denominator of the fraction.
  4. Voluntary Reduction of Hours.  If, during the Covered Period or the Alternative Payroll Covered Period the employee voluntarily requested and received a reduction of hours, then that employee will be excluded from the denominator of the fraction.  

In addition, there is a safe harbor to protect employers who reduce their FTE employee headcount but then increase the FTE employee headcount.  A borrower is exempt from the reduction in loan forgiveness based on a reduction in FTE employees if the borrower (1) reduced its FTE employee headcount between February 15, 2020 and April 26, 2020; and (2) the borrower restores its FTE headcount by June 30, 2020 to its FTE employee headcount in its pay period that included February 15, 2020.

Reduction in Amount Forgiven if 75% of PPP Loan Proceeds are Not Used for Payroll Costs

The SBA issued Interim Final Guidance on April 2, 2020 which included a rule requiring that 75% of PPP Loan proceeds be used for payroll costs.  Notably, this 75% rule is not in the CARES Act – the SBA simply created the rule out of whole-cloth.  Arguably, this rule is a legislative rule and not an interpretive rule, meaning the SBA did not have the authority to establish the rule; only Congress had the authority to create it, which it explicitly did not do.  Ultimately, however, this rule is likely to not matter: Congress, in one of its rare moments of bipartisanship, appears likely to eliminate this requirement.  Until it does so, however, the amount of the PPP Loan which may be forgiven is subject to this rule – and the Application makes it clear that the rule is interpreted strictly.

First, a borrower must determine its base level forgiveness amount, based on the amount of eligible expenses incurred and payments made during the Covered Period (or, as may be applicable, the Alternative Payroll Covered Period).

Second, the borrower must then reduce this (potentially already reduced) amount by taking into account the reduction required for a decrease in any employees’ salary or hourly wages during the Covered Period or the Alternative Payroll Covered Period by more than 25% compared to the first quarter of 2020.

Third, the borrower must then reduce this amount by taking into account the reduction required by the decreases in FTE employees.

Finally, once these three calculations are made, the borrower must divide the amount of the PPP Loan spent on payroll costs by 0.75 to take into account he 75% payroll cost expenditure rule.

The borrower will then be able to forgive the lower of (1) the entire PPP Loan, (2) all eligible expenses incurred and payments made during the Covered Period (or, as may be applicable, the Alternative Payroll Covered Period, or (3) the amount of the PPP Loan spent on payroll costs divided by 0.75.  Note that the division by 0.75 effectively adds 25% to the forgiveness over and above the amount of the payroll costs, so that $150,000 in payroll costs incurred and paid, for example, would result in $200,000 in forgiveness eligibility.

Documentation Required to Support the Application

The Application specifically identifies certain documents the borrower needs to submit to its lender with the Application.

In order to document payroll, including eligible cash compensation and non-cash benefit payments, from the Covered Period or, if applicable, the Alternative Payroll Covered Period, the borrower will need to attach the following documents to the Application:

  1. Bank account statements or third-party payroll service provider reports documenting the amount of cash compensation paid to employees;
  2. Tax forms (or equivalent third-party payroll service provider reports) for the periods that overlap with the Covered Period or the Alternative Payroll Covered Period showing payroll tax filings reported, or that will be reported, to the IRS (i.e., the Form 941) and the state quarterly business and individual employee wage reporting and unemployment insurance tax filings reported, or that will be reported, to the state. 
  3. Payment receipts, cancelled checks, or account statements documenting the amount of any employer contributions to employee health insurance and retirement plans that the Borrower included in the forgiveness amount.

In order to document FTE employee headcount at the relevant time period(s), the borrower will need to attach the following documents to the Application payroll tax filings reported, or that will be reported, to the IRS (i.e., the Form 941) and the state quarterly business and individual employee wage reporting and unemployment insurance tax filings reported, or that will be reported, to the state which will show, as elected by the borrower:

  1. The average number of FTE employees on payroll per month employed by the borrower between February 15, 2019 and June 30, 2019;
  2. The average number of FTE employees on payroll per month employed by the borrower between January 1, 2020 and February 29, 2020; or 
  3. In the case of a seasonal employer, the average number of FTE employees on payroll per month employed by the Borrower between February 15, 2019 and June 30, 2019; between January 1, 2020 and February 29, 2020; or any consecutive twelve-week period between May 1, 2019 and September 15, 2019. 

The selected time period must be the same time period selected for purposes of determining the ‘base’ amount of the PPP Loan which will be forgiven.

In order to document payments during the Covered Period which are not payroll costs, the borrower will need to attach the following documents to the Application:

  1. Business Mortgage Interest Payments: A copy of the lender amortization schedule and receipts or cancelled checks verifying eligible payments from the Covered Period or lender account statements from February 2020 and the months of the Covered Period through one month after the end of the Covered Period verifying interest amounts and eligible payments. 
  2. Business Rent or Lease Payments: A copy of the current lease agreement and receipts or cancelled checks verifying eligible payments from the Covered Period or lessor account statements from February 2020 and from the Covered Period through one month after the end of the Covered Period verifying eligible payments. 
  3. Business Utility Payments: Copies of invoices from February 2020 and those paid during the Covered Period and receipts, cancelled checks, or account statements verifying those eligible payments. 

Documentation the Borrower Must Maintain

In addition to requiring the borrower to submit certain documentation to its lender, the Application also describes a variety of documentation which the borrower must maintain in its records even without necessarily submitting it to its lender.  This documentation includes:

  1. The Application’s Schedule A Worksheet.  
  2. Documentation supporting the listing of each individual employee in the Application’s Schedule A Worksheet Table 1, including the “Salary/Hourly Wage Reduction” calculation, if necessary.
  3. Documentation supporting the listing of each individual employee in the Application’s Schedule A Worksheet Table 2; specifically, that each listed employee received during any single pay period in 2019 compensation at an annualized rate of more than $100,000. 
  4. Documentation regarding any employee job offers and refusals, firings for cause, voluntary resignations, and written requests by any employee for reductions in work schedule. 
  5. Documentation supporting the PPP Schedule A Worksheet “FTE Reduction Safe Harbor.”
  6. All records relating to the PPP Loan, including 
  7. Documentation submitted with the PPP Loan application;
  8. Documentation supporting the certifications as to the necessity of the loan request and eligibility for a PPP Loan;
  9. Documentation necessary to support the loan forgiveness application; and 
  10. Documentation demonstrating the borrower’s material compliance with PPP requirements.

Importantly, the borrower must retain all this documentation for six years after the date the loan is forgiven or repaid in full, and permit representatives of the SBA, including representatives of the SBA Office of Inspector General, to access the files upon request.

Certifications the Borrower Must Make

After all the issues borrowers faced prior to May 14 regarding the certifications on the initial PPP Loan application, it is important for borrowers to understand that this Application also includes a number of certifications.  Borrowers must be able to make all these certifications in order to (1) submit the Application to their lender and (2) be entitled to PPP Loan forgiveness.  The certifications are:

  1. The dollar amount for which forgiveness is requested:
  2. Was used to pay costs that are eligible for forgiveness (payroll costs to retain employees; business mortgage interest payments; business rent or lease payments; or business utility payments); 
  3. Includes all applicable reductions due to decreases in the number of full-time equivalent employees and salary/hourly wage reductions;
  4. Does not include nonpayroll costs in excess of 25% of the amount requested; and
  5. Does not exceed eight weeks’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner, capped at $15,385 per individual.
  6. The borrower understands that if PPP Loan proceeds were knowingly used for unauthorized purposes, the Federal government may pursue recovery of loan amounts and/or civil or criminal fraud charges.
  7. The borrower has accurately verified the payments for the eligible payroll and nonpayroll costs for which the borrower is requesting forgiveness.
  8. The borrower has submitted to the lender the required documentation verifying payroll costs, the existence of obligations and service (as applicable) prior to February 15, 2020, and eligible business mortgage interest payments, business rent or lease payments, and business utility payments.
  9. The information in the Loan Forgiveness Application and supporting documents and forms is true and correct in all material respects and the borrower understands that knowingly making a false statement to obtain forgiveness of an SBA guaranteed loan is punishable by imprisonment and/or a fine under a variety of Federal statutes. 
  10. The tax documents submitted to the lender are consistent with those the borrower has submitted or will submit to the IRS and/or state tax or workforce agency, and understands, acknowledges, and agrees that the lender can share the tax information with the SBA’s authorized representatives, including authorized representatives of the SBA Office of Inspector General, for the purpose of ensuring compliance with PPP requirements and all SBA reviews. 
  11. The borrower understands, acknowledges, and agrees that the SBA may request additional information to evaluate the Borrower’s eligibility for the PPP Loan and loan forgiveness, and that if the borrower fails to provide information requested by the SBA then the SBA may determine that the borrower was ineligible for the PPP Loan or may deny the loan forgiveness application. 

Conclusion

The CARES Act is the largest stimulus package in the history of the United States.  The PPP Loans authorized by the CARES Act are a full quarter of the stimulus package, $659 billion.  For most businesses, obtaining a PPP Loan was complicated in its own right.  Using the PPP Loan proceeds properly is also difficult.  But, with little guidance and an eleven (11) page application that fails to adequately provide easy to understand instructions, the forgiveness aspect of the PPP may well be the most incomprehensible aspect of the PPP Loan program.  Understanding it, however, is the key to insuring that you and your business properly take advantage of the law.

If you have any questions about the Paycheck Protection Program, other aspects of the CARES Act, or other tax, risk management, or business needs, please feel free to reach out to me.