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The Paycheck Protection Program and Loan Forgiveness

April 23, 2020


The CARES Act (the “Act”) hallmark provision is the potential for loan forgiveness under the Paycheck Protection Program (PPP). As PPP funds are received by businesses, now is the time to strategize for maximum loan forgiveness. The PPP has been advertised as a grant, and, in many respects, it can function like one. However, the onus is on businesses to earn 100% loan forgiveness. Many will find this a difficult endeavor. This article examines business loan forgiveness considerations. While generally applicable to a self-employed individual, there are some differences for the self-employed individual not outlined below.

The Act enumerates specific expenses that essentially generate a credit against the loan, reducing the amount that will need to be repaid. The Act provides an eight-week window to accumulate this credit, starting on the day the funds are disbursed to the borrower. For those that have already received funds, the clock is ticking.

What Are the Forgivable Expenses?

The Act identifies four categories of forgivable expense (the “credit”). A significant unanswered question is whether these costs need to be paid, incurred, or both paid and incurred during the eight-week period. Some guidance in the short-term would be most welcome.

  • Payroll Costs – Payroll costs include salaries and wages of employees up to a cap of $100,000 per year (annualized at $15,385 per employee over the eight-week period). In addition, employer-paid health insurance, employer-paid retirement contributions, and employer-paid state and local taxes on payroll (e.g., unemployment insurance) are included. The SBA issued Interim Final Rules on April 2, 2020 adding the requirement that at least 75% of the loan forgiveness amount must be comprised of payroll costs.The PPP maximum loan amount was calculated based on approximately 10 weeks (average monthly payroll multiplied by 2.5) of payroll costs. However, borrowers only get credit for eight weeks in the forgiveness calculation. Therefore, in the absence of an increase in payroll costs, businesses will need other qualifying expenses to bridge the gap.Additionally, it is worth noting that the legislative text requires a reduction in payroll costs for federal withholding and the employer and employees’ share of Social Security and Medicare tax. However, the concern is somewhat tempered, as the SBA FAQ on the PPP seems to suggest that loan forgiveness will be calculated on gross wages without a reduction for taxes. With the FAQ merely the SBA’s interpretation of the statute, additional authoritative guidance on this issue is needed.
  • Rent – Rent includes payments under a lease agreement in force before Feb. 15, 2020. One open question is how related party rent will be treated. The legislation has no direct prohibition on related-party rental payments but it does contain a prohibition against mortgage principal payments (as a non-qualifying expense). We will have to see if these concepts are reconciled.
  • Utilities – The Act defines utilities to include: electricity, gas, water, transportation, telephone, or internet service for which service began before Feb. 15, 2020.
  • Interest – The Act uses the term “covered mortgage obligation” to define interest payments that generate a forgiveness credit. The Act stipulates that the underlying debt must be a “mortgage on real or personal property” incurred before Feb. 15, 2020.

Is the Forgiveness of the Loan Considered Taxable Income?

The Act explicitly states that the forgiveness of debt under the PPP shall be excluded from gross income.

There is some question, however, regarding whether the aforementioned expenses that build the forgivable credit are deductible. More guidance is needed on the treatment of the expenses related to the forgiveness portion of the loans, however, we believe that these should be tax deductible. A determination to the contrary would deliver businesses an additional burden in the face of already unprecedented turmoil.

How Will the Forgiven Amount of the Loan Be Reduced?

The forgiven amount of the loan will be reduced for businesses that reduce their headcount and/or reduce wages paid to employees.

  • Headcount – If a business’s average full-time equivalent (FTE) employees during the eight-week period after the origination of PPP loan is less than the average FTEs during either the period from Feb. 15, 2019, to June 30, 2019, or Jan. 1, 2020, to Feb. 29, 2020, the forgiven amount is reduced by the percentage reduction in headcount. The business receiving the loan will be able to select whether to use the period from Feb. 15, 2019 to June 30, 2019 or the period from Jan. 1, 2020 to Feb. 29, 2020 as the denominator in determining the reduction percentage.
  • Wages – Businesses that reduce wages by more than 25% per employee as compared to the most recent full quarter before the loan was made will be required to reduce loan forgiveness further. Only the amount of the wage reduction in excess of 25% will result in a reduction to loan forgiveness. For purposes of this calculation, businesses only need to consider employees who make $100,000 or less per year.This can create an odd result. For example, if a business had two employees, one making $101,000 annualized and the other making $99,000. If the business reduced both employees to $50,000, arguably it would only be required to factor the latter into the wage reduction analysis. We expect additional guidance on this issue.Another open question is what happens when an employee is terminated? Clearly, this has an adverse impact on the FTE calculation. But does it create a second adverse impact by constituting a wage reduction? It seems like the answer should be ‘no,’ however, additional guidance would be helpful in clarifying this issue.

How Does a Business “Remedy” Reductions of Forgiveness?

The Act allows businesses to remedy FTE and wage reductions by June 30, 2020, but only for those reductions that occurred between Feb. 15, 2020 and April 26, 2020 (30 days from the enactment of the Act). Many take this to mean that as long as the business either rehires employees or restores wages by the end of June, there will not be a forgiveness reduction. Technically this can be a valid assumption, although a business only has eight weeks to build the loan forgiveness credit. The longer the business waits to restore these metrics, the less likely it will procure enough credits to fully extinguish the loan.

KSM Can Help

KSM is here to answer your questions and can help you prepare the necessary documentation to support your forgiveness calculation. Please reach out to your KSM advisor for help or complete this form.

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