So You Received Your PPP Loan: Awesome, Wow! What Comes Next? Do You Have a Clue What Happens Now? (with apologies to Lin-Manuel Miranda)
April 24, 2020
By Brian Bernhardt, John Burns, and Lyle Gravatt
$349 billion later or, perhaps, depending on when you are reading this blog article, $659 billion later, the Small Business Administration (the “SBA”) has disbursed all of the loan funds available to it under the Paycheck Protection Program (the “PPP Loans”) established under the CARES Act and the CARES Act supplemental funding bill. The funds went quickly, many larger “small” businesses received funding, and not enough “smaller” small businesses received funding.
If you or your business received a PPP Loan, congratulations. While two and a half months of payroll costs funding may not ensure your survival during and after the coronavirus pandemic, the funds will certainly help you navigate short-term issues.
Now that you have received (or are about to receive) the PPP Loan, though, you need to make sure that you understand what comes next – how can you use the PPP Loan proceeds? How can you ensure that the maximum amount of the PPP Loan is forgiven? And, given the controversy swirling about the potential unintended recipients of funding, how can you best ensure that, if and when the SBA knocks on your door, you can get it out of your office efficiently and effectively.
To paraphrase King George III in Hamilton: it’s awesome that you received your PPP Loan, but what comes next?
Allowable Uses of PPP Loan Proceeds
The first thing to make sure you know is what costs you may pay using the PPP Loan proceeds. The CARES Act identifies seven different uses:
- Payroll costs.
- Costs related to continuing group health care benefits during periods of paid sick, medical, or family leave, and related insurance premiums.
- Employee salaries, commissions, or similar compensations.
- Payments of mortgage interest (but not payments of mortgage principal or prepayment of mortgage interest).
- Interest on debt incurred before February 15, 2020.
There are two additional items to note related to these uses.
- First, the PPP Loan proceeds must be used by June 30, 2020.
- Second, you may use the PPP Loan proceeds to pay the above items going back to February 15, 2020. So, for instance, if you haven’t paid your March rent you can use the PPP Loan proceeds to pay it. More importantly, you can rehire employees you laid off in late February and early March and pay their salaries back to February 15, 2020 with the PPP Loan proceeds – in fact, this is one of the goals of the CARES Act, using PPP Loans to maintain and retain payroll and employee headcount. Keep in mind, though, that paying employees backpay may cause those employees to have to repay any unemployment insurance they received for the time period you are paying them.
All of this, of course, leads to the question – what in the world are “payroll costs”? And it is a good – and important – question. Payroll costs, for employers, are:
- Salary, wages, commissions, or similar compensation.
- Cash tips.
- Payment for vacation, parental, family, medical, or sick leave.
- Payment for dismissal or separation (such as severance payments).
- Payments for providing group health care benefits and related insurance premiums.
- Payments of retirement benefits (such as matching 401(k) payments).
- Payment of state and local employment taxes.
For self-employed individuals and sole proprietors, payroll costs are payments of any compensation to or income of that is a wage, commission, income, net earnings from self-employment, or similar compensation. Note that payroll costs do not include profit distributions to owners of S corporations or limited liability companies – all those years of taking lower salaries to avoid employment taxes have finally come back as a detriment.
Of course, there are exceptions to the definition of payroll costs, as well:
- Payroll costs do not include compensation of any individual of over $100,000 per year, based on annualizing the individual’s salary from February 15, 2020 through June 30, 2020. Importantly, although the CARES Act actually says nothing of the sort, the SBA has decided that this $100,000 cap applies only to cash compensation, not to non-cash benefits, such as employer contributions to defined-benefit or defined-contribution retirement plans; payments for providing employee group health care benefits and the related insurance premiums; and payment of state and local employment taxes assessed on compensation of employees.
- Payroll costs do not include Federal employment taxes.
- Payroll costs do not include compensation for employees whose principal place of residence is outside of the United States.
- Payroll costs do not include sick leave wages or family leave wages for which The Families First Coronavirus Response Act allows a payroll tax credit.
- Payroll costs do not include employer payments to independent contractors.
All of that is long, complicated, and detailed, but it is also critically important. These are the only allowable uses of PPP Loan proceeds. If you use the proceeds for a PPP Loan for these purposes, then there is no personal liability for repaying the PPP Loan and you get the benefit of the PPP Loan terms for any portion of the PPP Loan that is not forgivable – 1% per year, a two-year repayment term, and a deferral of the first repayment for six months after disbursement.
Maximizing Forgiveness of the PPP Loan
If receiving a PPP Loan is a benefit that will enable your business to get through the next 60 days, the provisions of the CARES Act that enable you to not have to pay the PPP Loan back may well help your business survive. As with getting a PPP Loan and using the PPP Loan for the right purposes, however, there are plenty of potential missteps that could limit the amount of the PPP Loan you may have forgiven. But if you follow the road laid out by the CARES Act and the SBA, you can maximize your PPP Loan forgiveness.
Determining how much of a PPP Loan you can convert into a grant which does not require repayment, however, requires the use of a skill many of us dislike: math. Lots of math. But let’s give it a try.
First, add up all of the costs incurred and payments made during the eight week period after you received the PPP Loan proceeds for the following expenses:
- Payroll costs (using the same definition used above).
- Mortgage interest payments (but not payments of mortgage principal or prepayment of mortgage interest) for mortgages that originated prior to February 15, 2020.
- Rent payments for leases that were entered into prior to February 15, 2020.
- Utility payments for utility obligations which were originally incurred prior to February 15, 2020.
Second, add up how much you spent between February 15, 2020 and June 30, 2020 for those same expenses.
Third, divide the eight week total determined under step one by the February – June total determined under step two. Then multiply that amount by 100 and make it a percentage. That is the percentage of the PPP Loan which may be forgiven.
For example, assume the following facts: (1) you received a PPP Loan of $100,000, (2) in the eight weeks after you received the PPP Loan you spent $75,000 of the PPP Loan proceeds on the four categories of identified expenses, and (3) between February 15, 2020 and June 30, 2020 you spent all $100,000 of the PPP Loan on the four categories of identified expenses. In this example, the eight week total of $75,000 divided by the February through June total of $100,000 equals 0.75. Multiply 0.75 by 100 and convert it to a percentage, and the result is 75% – meaning 75% of the PPP Loan, or $75,000, will be forgiven. The remaining 25% of the PPP loan will have to be repaid under the PPP Loan terms – 1% per year, a two year repayment term, and a deferral of the first repayment for six months after disbursement.
It may seem strange that the amount of your PPP Loan was calculated using a 10 week period (two and a half months), but the loan forgiveness period only covers an 8 week period. It almost seems as if the government wants your business to repay at least 20% of the loan, as described in the above example. That is not, however, the case. Keep in mind that the 10 week period for calculating the amount of the PPP Loan only takes into account payroll costs, while the 8 week loan forgiveness period allows the PPP Loan to be used for expenses other than payroll costs. The two extra weeks used in calculating the PPP Loan amount over the eight week loan forgiveness period? That’s 25% – and the SBA has issued a rule requiring businesses to use a maximum of 25% of their PPP Loan on the identified expenses other than payroll costs in order to obtain full loan forgiveness. As a result, if your business uses 75% of its PPP Loan during the eight week period on payroll costs and 25% on the other identifiable expenses during the eight week period then the entire PPP Loan will be forgivable.
Let’s go back to an example with similar facts to the prior example: (1) you received a PPP Loan of $100,000, (2) in the eight weeks after you received the PPP Loan you spent $75,000 of the PPP Loan proceeds on payroll expenses, and (3) in the eight weeks after you received the PPP Loan you spent $25,000 of the PPP Loan proceeds on the other four categories of identified expenses. In this example, the eight week total of $100,000 divided by the February through June total of $100,000 equals 1.00, and you have satisfied the requirement of using 75% of the PPP Loan for payroll costs. Multiply 1.00 by 100 and convert it to a percentage, and the result is 100% – meaning 100% of the PPP Loan will be forgiven.
So what happens if you don’t use 75% of the PPP Loan for payroll costs? Well, nothing too good: the amount of the PPP Loan forgiven will be reduced if you don’t use at least 75% of the PPP Loan proceeds during the eight weeks after you receive the PPP Loan for payroll costs.
For example: (1) you received a PPP Loan of $100,000, (2) in the eight weeks after you received the PPP Loan you spent $50,000 of the PPP Loan proceeds on payroll expenses, and (3) in the eight weeks after you received the PPP Loan you spent $50,000 of the PPP Loan proceeds on the other four categories of identified expenses. Since you used all of the PPP Loan during the eight weeks after disbursement, it appears, on first glance, that all of the PPP Loan would be forgiven. But you did not use enough of the PPP Loan for payroll costs: instead of using 75% of the PPP Loan for payroll costs you used 50% of the PPP Loan for payroll costs, only 2/3 of the required amount. As a result, the amount of the PPP Loan you may have forgiven is only 2/3 of the PPP Loan, or $67,666.67.
It is easy to see the impact of not using a minimum of 75% of the PPP Loan proceeds for payroll costs. One way to help ensure that you do so is by opening, if you don’t already have one, a separate payroll account at your financial institution. Deposit over 75% of the PPP Loan proceeds into that payroll account and use the entirety of those funds for payroll. Not all of the funds will actually count as payroll costs – you’ll still be using some of the funds for Federal employment taxes and you may be using some of the funds for cash compensation in excess of $100,000. But the use of a separate account is likely the easiest way to track the use of the PPP Loan proceeds, the easiest way to calculate the amount of the PPP Loan proceeds that constitute payroll costs, and the easiest way to make sure that you use at least 75% of the PPP Loan for payroll costs. Moreover, since cash is fungible, you can use your other funds, money you would otherwise be using on payroll without the PPP Loan, on anything you need, even – since the money is not PPP Loan proceeds – uses not allowed for PPP Loan proceeds.
Unfortunately, the CARES Act and the SBA have created two other exceptions to the PPP Loan forgiveness rule which may limit and decrease the forgivable amount of your PPP Loan. These limitations line up with the policy of the CARES Act in general and the Paycheck Protection Program specifically – maintaining employees on payroll and maintaining payroll. Again, you’re going to need to use your math skills…
1. Reduction of loan forgiveness for reducing full time equivalent (“FTE”) employee headcount. The amount of the PPP Loan forgiven will be reduced if you reduces your FTE workforce. Since a policy goal of the CARES Act and the SBA is maintaining employment, your business will not be able to have as much of the PPP Loan forgiven if you do not maintain FTE headcount. Again, this issue requires math…
To determine whether a reduction in FTE headcount will cause a reduction in loan forgiveness, divide (1) your average number of FTE employees per month between February 15, 2020 – June 30, 2020 by (2) either, at your election, (a) your average number of FTE employees per month between February 15, 2019 and June 30, 2019 (this is the required choice for seasonal employers) or (b) your average number of FTE employees per month between January 1, 2020 and February 29, 2020.
You can avoid this reduction, however, even if you reduce your workforce compared to either the February 15, 2019 through June 30, 2019 time period or the January 1, 2020 through February 29, 2020 time period. To avoid the reduction, you need to increase your FTE headcount back to your average FTE employees per month between February 15, 2020 – June 30, 2020 and do so by June 30, 2020. Essentially, if you laid off employees and are facing a reduction in the amount of the PPP Loan you may have forgiven, you can avoid the reduction by increasing your FTE headcount to where it was previously, by rehiring the same, or different, employees.
2. Reduction of loan forgiveness for reducing salaries and wages. The amount of the PPP Loan forgiven is reduced if you reduce your employees’ wages or salary in certain circumstances. The key is whether you reduced any single employee’s wages or salary between February 15, 2020 and June 30, 2020 by more than 25% of that employee’s salary during the first quarter of 2020. If so, then the amount of the PPP Loan forgiven is reduced by the amount of wages and salary reduced over the 25% threshold. Keep in mind, though, that this reduction rule does not apply to wages and salaries over $100,000 in 2019 on an annualized basis. And, again, by increasing the wages or salary by June 30, 2020 so that the reduction is less than 25%, you can avoid the reduction in PPP Loan forgiveness.
Avoiding the Long Arm of the Law
So now you have received your PPP Loan, you’ve used your PPP Loan, and you’ve had some or all of your PPP Loan forgiven (or are in the process of having it forgiven). Is that it? Do you simply move and continue to use every skill you have to maintain your business, to insure that it survives into whatever comes next, the so called ‘new normal’?
Well, yes and no. Yes, you need to do everything you can, starting yesterday, regardless of the amount of the PPP Loan you received and/or had forgiven, to make sure your business survives for whatever comes next. At the same time, however, you need to be ready to justify to the SBA, if it asks, that you were entitled (1) to the PPP Loan, (2) to use the PPP Loan proceeds in the manner you used them, and (3) that the amount of the PPP Loan you had forgiven was the correct amount.
Recent press accounts detail backlash at some companies – Shake Shack, Ruth’s Chris’ Steakhouse, Potbelly, Taco Cabana, and Harvard University, to name only the most commonly mentioned entities – that received money under the CARES Act (both the PPP Loan provisions and otherwise) at the potential expense of actual local small businesses. You may be one of those local small businesses. You may be a local small business with multiple locations that doesn’t look quite small. You may be a restaurant that received a carve-out from certain employee limitations in the Paycheck Protection Program. You may even be a large (potentially public) multi-state employer with tens (or hundred) of millions of dollars in annual revenue that simply has 500 or fewer employees.
In all of these cases, especially the larger you are, the SBA may come looking at your PPP Loan application, the manner in which you used the funds, and what amount of PPP Loan you had forgiven. And nobody wants to be on the front page of a newspaper, or website, as the poster-child for greed in a pandemic induced economic collapse.
For instance, on April 23, 2020, the SBA updated its PPP Loans Frequently Asked Questions to ask whether “large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan.” The answer, while involving a host of details, is essentially “no.” The SBA focused on the various certifications companies need to make when applying for a PPP Loan. Specifically, before submitting a PPP Loan application, all businesses are required to certify, in good faith, that “[c]urrent economic uncertainty makes this loan request necessary to support the[ir] ongoing operations…” They must make this certification taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. As a result, the SBA announced it to be “unlikely” that a public company with substantial market value and access to capital markets would be able to make the required certification in good faith; if it does so, the business should be prepared to demonstrate to SBA, upon request, the basis for its certification.
While this answer applied only to “large companies with adequate sources of liquidity to support the business’s ongoing operations” and focused on public companies, the basis of the analysis applies equally to every PPP Loan borrower – you must be able to certify, in good faith, taking into account your current business activity and your ability to access other sources of liquidity sufficient to support your ongoing operations in a manner that is not significantly detrimental to the business that “[c]urrent economic uncertainty makes [the PPP Loan] request necessary to support [your] ongoing operations…” Moreover, if the SBA asks, you need to be able to demonstrate – likely using profit and loss statements, financial statements, and other financial and accounting measures – the basis for your certification.
The Treasury Department, through Treasury Secretary Mnuchin, announced that the SBA will act, in effect, as inspectors general to oversee the proper application of the PPP Loans and requests for forgiveness. If you followed the rules, and can demonstrate with appropriate documents that you did so, then all should be well. If not, well, then you may want to consider the impact of potential personal liability for forgiven PPP Loans, not asking for loan forgiveness, or even, in some cases, repaying the PPP Loan – the SBA will treat any borrower that applied for a PPP Loan prior to April 23, 2020 and repays the loan in full by May 7, 2020 to have made the required certification in good faith. Essentially, if you applied for a PPP Loan prior to April 23, 2020 because it was “free money” and you did not “really” need the funds and you received the PPP Loan, the SBA will let you repay the loan by May 7 without further repercussions.
The CARES Act, and the supplemental funding bill, are the largest stimulus package in the history of the United States. The PPP Loans authorized by the CARES Act and the supplemental funding bill are a full quarter of the stimulus package. The initial $349 billion of PPP Loans were approved for disbursement to borrowers in thirteen days. The supplemental funding of $310 billion will likely be approved for disbursement to borrowers far more quickly. While obtaining a PPP Loan is complicated in its own right, it is only the start of the process. Using the PPP Loan properly, understanding the payment requirements to ensure maximum forgiveness of the PPP Loan, and making sure you are entitled to the PPP Loan in the first place based on the required certification (and being able to prove it), are critically important as well. Once you have your PPP Loan, the question, just like the one raised by King George III in Hamilton, becomes, “Do you have a clue what happens now?” The answer to that question is critical over the next few months.
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 us.