Paycheck Protection Program Forgiveness Overview
By: Kevan Lee Deckelmann, and Tara Walker
We want to remind you of some of the parameters that the Small Business Administration (“SBA”) will be using to determine whether some or all of the Paycheck Protection Program (“PPP”) loan proceeds that you have received will be forgiven. Some literature regarding this program has described the forgiven portion as a “grant.” Remember that whether your loan maybe forgiven, in part or in full, will depend on factors beginning on the date when your loan funds are disbursed and continuing for an eight-week period. For that reason, if possible, you should review this information before your loan proceeds are disbursed, as you may need to take steps to prepare.
Forgiveness generally is calculated in two ways: (1) based on the type of costs, and (2) based on a formula established by the SBA.
What kinds of costs will be forgiven?
The intent of the Paycheck Protection Program is to protect and preserve employee jobs and compensation, so most of your loan proceeds must be used to pay your employees. In new rules, the SBA has said that only 25% of the loan may be used on allowable non-payroll costs. Allowable non-payroll costs include rent (for a lease for real or personal property in force before February 15, 2020), utilities (electricity, gas, water, transportation, telephone, or internet access), and interest on mortgage payments for your business (provided those loans were taken before February 15, 2020). Although you may spend loan proceeds on other types of interest, only mortgage interest will be forgiven. Subject to these restrictions, whatever loan proceeds you are able to spend in the first eight weeks after receiving your loan are eligible for loan forgiveness.
Payroll costs should be 75% of the value of your loan, if you want to maximize forgiveness eligibility. These include the following paid by the employer:
- Salaries, wages, commissions, or similar compensation that you pay your employees or yourself;
- If you’re self-employed or an independent contractor, the net compensation your receive from your business that is similar to wages, commissions, income, or net earnings;
- Payment of wages even if your employees are on leave for vacation, parental, family or sick leave under your company policies (but not under the new paid leave laws, see below);
- If your employees receive tips, it includes cash tips or equivalent;
- Separation or severance payments;
- Premiums and other expenses for group health care benefits and retirement benefits; and
- Only state or local taxes on the compensation of employees.
Payroll costs do not include the following:
- Federal taxes, including withholdings for Medicare and Social Security (FICA), or unemployment (FUTA), or federal income tax withholdings;
- Any amount of compensation, when prorated, would exceed $100,000 per year for any employee;
- Compensation for any employee whose principal residence is outside of the U.S.; and
- Any wages or amounts paid to employees who are taking leave under the Families First on a Response Act for Emergency Paid Sick Leave or Emergency Expanded Family and Medical Leave (for childcare) because you are eligible for a tax credit for the same amounts.
How does the SBA calculate forgiveness?
Forgiveness of your loan will also be considered with a second calculation, based on a formula that the SBA will use to arrive at an overall percentage of the reduction of amounts that can be forgiven. A simple way to think of these calculations is that Congress wanted to press the “pause” button so that these loans were used to keep the same employees (or the same number of employees) working for the same enterprises at the same (or better) rates when they are able to return to work. Thus, the percentage of reduction is based on two considerations:
(1) Headcount. This is the average number of full-time equivalent employees that are on the payroll during the 8-week period of the loan (starting from the date the funds are disbursed and continuing for 8 weeks), as compared to the average number of full-time equivalent employees in either February 15 — June 30, 2019, or January 1 — February 29,2020. The comparator (2019 or 2020) period is your choice (unless you are a seasonal employer, and thus must use the 2019 period), which you might make, for example, if you had a reduction of employees in early 2020, before the COVID-19 pandemic.
What are full-time equivalent employees?
The average number of full-time equivalent employees is a separate calculation that is based on the number of hours of scheduled work. So, in other words, if two part-time 20-hour/week employees leave the company, and you replaced them with one full-time 40-hour/week employee, it should not affect your forgiveness.
I have already laid off employees, can I rehire them?
Yes. The SBA will allow you to rehire employees to restore your “headcount,”but one important thing to remember is that you only have 8 weeks to spend the loan proceeds beginning on the date of disbursement. This is why you may want to plan ahead of time, to take steps needed to rehire employees before the loan is funded to maximize your forgiveness eligibility.
(2) Wage Levels. In addition to the head count, the SBA will also be looking at your wage levels for any employees who typically earn $100,000 or less per year. Given the market changes, some decrease in pay for employees may be expected, so you are permitted to decrease these employees’ pay by an allowable 25% reduction without affecting your forgiveness level. Any reduction over that 25%, however, will reduce the forgiveness of your loan according to the overall salary reduction beyond 25%. For example, if you have ten employees, all of whom typically earn $80,000 per year, and you reduced all of their salaries to $40,000 (i.e. a 50% reduction), amounting to an overall reduction in wages of $61,538 during the 8-week period, your loan forgiveness would be reduced by $30,769 (i.e., the actual dollars in overall wage reduction beyond the allowable 25%).
If employees’ wages are reduced, the reduction amount is compared to what—pre-COVID-19 wages or wages from 2019?
The reduction is compared to the “most recent full quarter during which the employee was employed” before the 8-week loan period. So for example, if you receive loan funds on April 15, 2020, the comparator will be Q1 (January 1—March 31, 2020).
Is this all employees’ wages, or only some?
This reduction calculation does not apply to any employees who earned an annual amount of over $100,000 during any pay period in 2019. So, for example, if someone were earning $200,000 per year, you are permitted to reduce their compensation by any amount (40% or 50%) without affecting your forgiveness calculation. Technically, new hires in 2020 (at any salary amount) are included.
There is a savings clause that allows you to rehire employees for your headcount, or restore salary for covered employees, without reducing loan forgiveness. The savings clause provides that any reductions to headcount (or salary) made on or before April 26, 2020 will not reduce your loan forgiveness amount provided that you restore headcount (or salary) by June 30, 2020. However, remember that you must expend the funds within 8 weeks of disbursement of the loan, so you would need to expend payroll costs within the 8 weeks to have them forgiven.
These two formulas will be applied to determine if the forgiveness of the loan should be reduced, but not increased. In other words, you should not expect to hire employees or increase their salaries to increase the forgiveness amounts. Additionally, it is expected that the SBA will clarify that loan forgiveness can never be reduced below zero percent forgiveness. Additionally, if the loan amount is forgiven in part or in full, the law makes clear that should not increase your tax liability (for forgiveness of debt).
We are expecting further guidance from the SBA with more precise information on forgiveness. When that arrives, we will update this information.
The COVID-19 crisis is rapidly evolving and requiring businesses to adapt quickly to the legal, regulatory, economic, and community impacts. Our business law team is monitoring these developments in real time and we’re here to support and assist you as needed. Please do not hesitate to reach out if we can be helpful to you.