On Friday, May 15, 2020, the Small Business Administration (SBA) released the 11-page form that borrowers should complete and remit to their lender, in order to secure full or partial forgiveness of their Payroll Protection Program (“PPP”) loan. Borrowers and their advisers had been eagerly awaiting guidance on exactly how to compute the maximum forgiveness available. You can find the form here.

The form is deceptively simple because the volume of computations required is significant. Consider, for example, the “salary / hourly wage reduction” at the bottom of page 7 and the top of page 8. This computation must be done separately for each and every employee.

Observations on the PPP Loan Forgiveness Application.

  • Some commentators had said that if a company did not spend 75% of their PPP loan for payroll (as defined for this purpose), that none of the loan is eligible for forgiveness. The mechanics of the form prove that this is not true by computing the maximum forgiveness as total eligible payroll costs divided by 75%, not the minimum forgiveness.
  • There is a relief for businesses whose payroll period does not line up cleanly with the 8-week (56-day) covered period. If the payroll period is bi-weekly (or more frequent), then the employer can elect to use the “alternative payroll covered period” for counting payroll costs only, which begins on the first day of the next pay period following the beginning of the covered period. The “alternative payroll covered period” runs for 8 weeks (56 days) from that point. This alternative period is only for payroll tests. Providing an alternative testing period that better coincides with the company’s payroll period demonstrates welcome flexibility from the SBA.
    • Example from the SBA instructions. “… If the borrower received its PPP loan proceeds on Monday, April 20, and the first day of its first pay period following its PPP loan disbursement is Sunday, April 26, the first day of the Alternative Payroll Covered Period is April 26 and the last day of the Alternative Payroll Covered Period is Saturday, June 20.”
  • Based on the mechanical workings of the application and its worksheets, the calculation does not appear to allow forgiveness for non-compensation payroll expenses for non-employee owners. The owners are partners of partnerships, members of LLCs, and sole proprietors. The expenses in question are health insurance, employer retirement contributions, and state unemployment. It is not clear that this is the correct application of the law, but it is certainly how the form is working.

For owners of partnerships and LLCs that are paid a guaranteed payment for health insurance, it could be argued that the payment of health insurance is also cash compensation. Good news – This would allow a deduction for the health insurance payment. Bad news – If the owner is already paid over $100,000 a year, then this thought process adds no benefit since payments to them are already at the maximum allowed.

  • Regarding the reduction in forgiveness for maintaining payroll through June 30, borrowers should not generalize about how this is going to work for them. There are safe harbors and exceptions, which can produce unexpected results. Wise tax advisors do not project your refund or balance due based on a stack of tax documents and this process is no different.
  • We now know how a full-time equivalent (“FTE”) is actually defined for the PPP forgiveness regime. Many had previously assumed that an FTE is 30 hours per week as under the Affordable Care Act. We now know that an FTE is 40 hours for this purpose, and it is measured on an employee-by-employee basis.
  • For each employee, take their average hours worked per week, divide by 40, and round to the nearest tent. The maximum for any one employee is 1.0.
  • Consider these examples.
    • An employee who works 50 hours on average per week is 0 FTE (50/40 = 1.25, limited to 1.0).
    • An employee who works 40 hours on average per week is 0 FTE (40/40 = 1.00).
    • An employee who works 30 hours on average per week is 8 FTE (30/40 = 0.75, rounded to 0.8).
    • An employee who works 20 hours on average per week is 5 FTE (20/40 = 0.50).
  • There is also an alternate, simplified computation where each person who works an average of 40 hours per week or more is 1.0 FTE, and each worker who averages less than 40 hours per week is 0.5 FTE. Arguably, those facing limits on forgiveness based on the FTE computation should compute it both ways. This simplified method should result in a larger FTE count where the business has many employees with a few hours per week, but it is not clear that having less FTEs will generate a better end result.
  • Eligible non-payroll costs are those (1) paid during the covered period, or (2) incurred during the covered period and paid on the next billing date after the covered period. Again, more flexibility is granted. But you do not get to choose an alternative period as in payroll.
  • It appears that all non-payroll costs paid during the covered period are eligible, as long as it is under an agreement dated before 2/15/2020. This includes interest on debt, rents, and utilities. So if you caught up on rent during the covered period (paying actually more than 8 weeks of rent because you were behind on rent when the covered period began), those payments appear to qualify.
  • We now know that covered utilities include “electricity, gas, water, transportation, telephone, or internet access”.
    • For this purpose it is not clear what “transportation” is – perhaps it is the cost of delivery of the utilities.
    • Can we further assume that “gas” includes auto and truck fuel? It is not clear, but the “Interim Final Rules” released by the SBA suggests that the answer is “yes”.

Planning ideas.

  • If your company did not apply for PPP funds, it is reported that, as of this writing, there is still money available. Apply now. If you have already applied but you understated the amount available, ask your lender if you can apply for additional funds. An example might be a partnership or LLC that did not consider payments to owners, which is now clearly allowed.
  • If your company has not funded all of its retirement obligations through the end of the covered period, pay those before the covered period ends.
  • There is a possibility of prepaid rents being eligible. Note that the application, page 2, under the instructions for line 2, warns the applicant not to include mortgage interest prepayment. There is no such prohibition in the description of rents.
  • For the forgiveness allocable to rents, remember to consider personal property rents. Think auto leases, copiers, etc.
  • There appears to be no prohibition on related party rents. If those are in arrears, get them current during the covered period.

Further developments.

Borrowers may not have seen the end of the guidance yet, even though the end of the 8-week covered period for forgiveness testing is approaching. Several bills have been introduced to make technical changes to the program. The areas where changes may occur include:

  1. Whether the expenses paid using PPP funds are deductible for income tax purposes.
  2. Whether the covered period for PPP spending will extend beyond 8 weeks.
  3. Whether at least 75% of the eligible forgiveness must be used for compensation.
  4. Whether any amount not forgiven has to be repaid within 2 years.
  5. Whether businesses with forgiven PPP loans continue to be restricting from deferring payroll taxes under the CARES Act.

Further, there are still many unanswered questions about this program. For example, how does the receipt of PPP funds affect the basis of the owners of LLCs, partnerships, and S-corporations? More guidance is still needed.

Your action.

Please consult with your DMJ advisor before the covered period expires, to see if you have done everything to maximize your PPP forgiveness. For example, companies that have downsized personnel may be able to restore payrolls by June 30 and reduce or eliminate their limited forgiveness penalty.

DMJ Responses.

We will continue to watch for future developments in this area.

DMJ is working now to create a template to compute the maximum forgiveness. We expect that to be available soon and available to assist our clients. Obviously, this cannot be completed until we know that all of the rules and tests are in their final form.

Please contact us if you would like to discuss further.

R. Milton Howell III, CPA, CSEP
R. Milton Howell III, CPA, CSEP

Milton is experienced in taxation issues including, tax research for both open and closed transactions, structuring complex tax transactions, estate and income tax planning, and representing clients before tax authorities. As DMJ’s Director of Tax Services, Milton regularly writes and reviews articles in local, regional, and national publications on tax matters and spends significant time monitoring current tax issues and legislation.

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