Now that the Paycheck Protection Program (PPP) loan application period has ended, businesses that have taken PPP loans are concerned about meeting eligibility for loan forgiveness. PPP loans are generally forgivable if a business uses at least 60% of the loan proceeds for eligible payroll costs over a covered period of eight weeks or 24 weeks, according to the period the borrower selected. Non-payroll costs also are eligible for forgiveness if they meet certain eligibility requirements.
The Small Business Association (SBA) and the U.S. Treasury issued interim final rules (IFR) in late August that provide additional guidance on eligible expenses related to PPP loan forgiveness. The SBA is responsible for administering these loans. The intent was to provide clarification and guidance on the ownership percentage that triggers the owner compensation rule for forgiveness and the eligibility limits on forgiveness for certain non-payroll costs.
Owner-Employee Limitations
In previous rules about PPP loans, compensation for S corporation and C corporation owners was limited to the lesser of $20,833 or 20.833% of their 2019 compensation for a 24-week covered period, or the lesser of $15,385 or 15.385% of their 2019 compensation for an eight-week covered period.
The new IFR allows business owners with small ownership percentages the opportunity for greater salary forgiveness. It states that expenses attributable to individual shareholders owning less than 5% in the company are not subject to the owner-level maximum compensation limits. That means that businesses with non-owner employees, or owners having less than a 5% stake, are eligible for a maximum salary forgiveness of up to $46,154 per employee for the 24-week covered period, or up to $15,385 per employee for the eight-week covered period. The cap for general partners that is subject to self-employment tax is limited to 2.5/12 of their 2019 net earnings (or 20.83%) from self-employment.
The IFR clarifies qualified non-payroll costs related to rent that may be eligible for loan forgiveness. The situations covered include the use of a home office, subleases and related-party rental expenses.
Qualified Non-Payroll Expenses for Home Offices and Subleases
Typical home office expense deductions can include mortgage interest, residential rent, utilities, real estate taxes, internet and telephone expenses, repairs, cleaning and maintenance. For PPP loan forgiveness, only mortgage interest, rent and certain utilities are allowed to determine the qualified non-payroll costs.
In situations where a business owner rents a building and subleases some of the space, only the net rent the owner actually pays is eligible as a forgivable non-payroll cost. For example, if a business owner rents space for $10,000 per month and subleases part of it for $2,500 per month, only the net difference of their $7,500 rental payment per month is eligible for loan forgiveness.
If the business owner owns the building and leases space to a tenant, the mortgage interest is similarly limited according to what proportion of the building is rented. In the example noted above, 75% of the mortgage interest would be eligible for loan forgiveness.
If a business owner shares space with another tenant, they should follow the same allocation ratio used for rent, mortgage interest and/or utilities on their 2019 tax return. If the business was started in 2020, they should allocate the rent or mortgage according to how they plan to prorate those expenses on their 2020 tax returns.
Related-Party Rentals
The IFR clarifies that PPP loans are intended to assist businesses cover non-payroll costs owed to third parties, not payments to a business’s owner that occur because of how the business is structured.
If the owner of the real estate and the business are the same, the related-party rent is limited to the mortgage interest paid by the real estate entity during the covered period. The IFR clarifies that any common ownership between the business and the real estate is considered a related party for these purposes. There does not appear to be a de minimis exclusion.
If the business expenses the mortgage interest that the real estate entity paid, the real estate entity is not permitted to use the mortgage interest as an eligible cost if it also has a PPP loan. Mortgage interest payments paid to a related party are not eligible for forgiveness.
It is possible that the SBA related-party rules may apply. For example, if one spouse or related party owns the real estate and another spouse or related party owns the operating entity, the rent is limited to the mortgage interest. If the ownership of the real estate and operating company is among children, parents, siblings or spouses but there is no direct common ownership, the eligible related-party rent may be impacted in a situation where there is no mortgage on the related-party real estate. We do not anticipate that any of the related party rent in this instance will be a qualified expense.
Click here to read the text of the IFR guidance. PPP loan recipients are advised to check the SBA website to stay up-to-date on the latest guidance.
Please contact DMJPS & Co., PLLC to discuss this further.