PPP and Loan Forgiveness – Things to Consider Now

PPP and Loan Forgiveness – Things to Consider Now – Shannon & Associates CPAs Kent, WA

So now you have your loan or have an application pending with high hopes – what is the next thing to be concerned with?

We have been helping our friends and clients for a while now, and one thing that is certain is that the Paycheck Protection Program (PPP) has been a challenging process for many businesses. There are still many companies hung up in the application process or awaiting funding. Alternatively, you may have made it through the tough process and received your funding. Whichever spot you find yourself in, now is the time to start planning for the next steps to ensure that whatever funds are received, the max is forgiven.

The CARES Act established the initial guidelines on how much of the PPP funds can be forgiven. The SBA, as the program implementor, along with input from the Dept of Treasury, have since provided additional guidance. However, there are still many questions as to what best practices for compliance will look like. New information is coming out daily and experts suggest we will have more guidance in the coming weeks. Until then, let’s talk about what guidance we do have.

The “Forgiveness” of PPP Funds

The PPP allows for loan funds to be forgiven, including accrued interest,  for payroll costs, rent, utilities and interest, as defined, that are paid during the “Covered Period”, defined as the 8-week period immediately after receiving the loan proceeds. At least 75% of the loan amount must be used for “Payroll Costs” and only up to 25% of the loan amount can be paid for Rent, Utilities, and Interest. Amounts paid outside of these parameters will not be forgiven. To clarify no more than 25% of the forgivable amount can be used on these costs. For example, if you got a $1 million loan, but don’t spend 75% on payroll costs ($750,000) and only spend $600,000, and spend $400,000 on the other covered items, forgiveness is limited to $600,000/.75= $800,000.  This would breakdown as $600,000 in payroll costs and $200,000 in other costs forgiven and $200,000 will not be forgiven.

For any amount not forgiven on the loan, interest will accrue at 1%, with the first six months of full principal and interest loan payments to be deferred over the two-year loan term.

How are these cost buckets defined?

  • Payroll Costs – There has been a lack of clarity regarding the PPP application process in terms of what should be included in the payroll calculation and, thereby, maximum loan proceeds. There are still similar questions around this surrounding forgiveness, but the SBA has clarified that at least 75% of the loan forgiveness amount must be attributed to payroll costs. The SBA also clarified that payroll costs include: salaries, wages, commissions or similar compensation, and tips or equivalent  of employees up to a cap of $100,000 per year (cash compensation), plus employer paid health insurance, retirement benefits, vacation, family medical and sick leave (if not used for the credit), and state and local taxes on payroll (all non-cash benefits). Payroll costs do not include an employer’s portion of Federal payroll taxes.
  • Rent – This includes payments to under a lease agreement in force before February 15, 2020. These payments can be to a third-party lessor or a related entity. Although no definitive guidance has been released, most experts believe this is intended for leases of real property.     
  • Utilities – Utilities include electricity, gas, water, transportation, telephone (regular and cell phones), and internet service beginning before February 15, 2020. 
  • Interest – Interest on “covered mortgage obligations” are eligible for forgiveness. Interest payments can be related to any debt obligation that is a liability of the borrower incurred before February 15, 2020. It does not include any payments on principal. The Act states that the underlying debt must be a “mortgage on real or personal property.” This would include debt on real property that is secured by a traditional mortgage lien as well as working capital lines of credit and other indebtedness where a UCC-1 is filed on the borrower’s personal property.

Intent of Forgiveness Provisions and How that works

The intent of the CARES Act is to keep employees working at wages comparable to pre- COVID-19 levels. This even means businesses forced to close; the idea is to use this money to keep those employees paid. So, if the company experiences a reduction of its workforce or a reduction of salaries and wages during the Covered Period, the amount of the loan forgiveness is reduced.

Employee Reduction Impact

The CARES Act provides that the amount of loan forgiveness is reduced by multiplying the amount eligible for forgiveness by the quotient obtained by dividing:  

Monthly average full-time equivalent (FTE) employees during the Covered Period divided by at the election of the borrower, the monthly average FTE employees of either of the following periods:

  • February 15, 2019 – June 30, 2019 or
  • January 1, 2020 – February 29, 2020

Salary Reduction Impact

The amount of loan forgiveness is also reduced by any reduction in salary or wages of any employee that is in excess of 25% of their total salary during the most recent full quarter they were employed. Only employees earning less than an annualized rate of $100,000 during 2019 are included in this calculation.   

These descriptions appear simple on the face, but there are other factors created by wording in the regulations that make them confusing. The bottom line is we do not have enough information at this point. However, we are hopeful that additional guidance will be issued in the coming weeks, including examples of how the salary and workforce reduction rules will apply.

Reduction Correction – It Might Not Be Too late

The CARES Act also contains provisions for businesses to remedy any reduction in the forgiveness. Reductions in employment or wages that occur between February 15, 2020, and April 26, 2020 shall not reduce forgiveness if by June 30, 2020 the borrower eliminates the reductions by re-hiring employees or restoring wages. We expect more information to come out on these provisions. But keep in mind they will all be centered on getting your employee count and dollars for those employees up to pre-Covid levels.

Other Considerations and Potential Pitfalls

The good news is that although loan forgiveness is typically taxable, the CARES Act states that forgiveness of debt under the PPP will not be taxable to the borrower on a Federal level. At the state level, many will automatically conform, but other states will have to determine if they will also conform to the Federal regulations.  

But even though the loan forgiveness may not be taxable income, it is possible you won’t get a tax deduction for the expenses paid with PPP funds either. This remains to be seen.

Another consideration is that, remember that the calculation to determine the loan amount was 2.5x payroll costs. The forgiveness period is only 8 weeks- or two months’ worth. The other portion of the loan amount was allowed for Companies to pay those other costs as noted above. It could be possible that you retain and pay your employees and still do not have full forgiveness simply based on the math and lack of other qualified expenditures to use up those proceeds. Accordingly, employers may need to increase payroll costs above the amounts used for obtaining the loan to get to the 75 percent threshold needed for full PPP loan forgiveness. So, it will be important to think of strategies such as keeping bonuses paid or paying commissions even if not earned to keep those salaries up.

Best Practices and Other Thoughts

Forgiveness is not guaranteed. The loan forgiveness process will be administered by your PPP lender based on SBA guidance and the lender has 60 days to decide on forgiveness. Lenders will require supporting documentation to validate your conclusions and calculations.

Companies will need to work closely with their lender and advisor to understand the best practices for documenting the use of funds. Some banks are instructing companies to open a separate bank account, while others are funding to an existing account. Either way, we recommend keeping meticulous accounting records. This may include setting up separate general ledger accounts for posting payments made with the funds, keeping a separate spreadsheet of details, as well as keeping copies of all support for payments made such as payroll records, health insurance invoices, rent or mortgage interest payments and utility bills.

If you have an S Corporation, make sure you are paying the shareholders a salary. Many S Corp owners take out distributions during the year for some portion of their compensation. While that is a benefit of an S Corp, it is does not constitute payroll compensation as far as the PPP is concerned. However, keep in mind that the PPP program does exclude payroll over $100,000 for any individual making more than that for the year.

This is a lot of information and more changes are coming but Shannon & Associates is here to help. Please reach out to us directly for any questions you may have at any time!

Shannon & Associates is offering a Sample PPP Loan Forgiveness Calculator. If you are interested in this, email us today.

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