The Paycheck Protection Program (PPP) was one of the most highly anticipated sections of the CARES Act that was passed on March 27, 2020. Business owners flocked to their lending institutions to apply for the funds to keep their companies afloat and employees paid during the COVID-19 Pandemic. The reason that the PPP loan is so attractive is that it can be fully forgiven, as long as certain requirements are met by the recipient. But as loans were dispersed starting around mid-April, the rules for forgiveness came with more questions than answers. Fortunately, on Friday, May 15th, the Loan Forgiveness Application was released, providing some much-needed clarity. This article addresses the main issues that the application and instructions helped clear up.
Alternative Payroll Covered Period
The eight-week “covered period” of the PPP loan generally starts on the date of the loan disbursement and ends eight weeks later. Instead, now borrowers can elect to use an “alternative payroll covered period” that aligns with their regularly scheduled payroll dates. However, the period must begin with the first payroll following the date the loan was received. For example, if a company receives their PPP loan on May 1st but the next payroll is not until May 6th, then their eight-week period can begin on May 6th instead of May 1st. The borrower must indicate on the application that they are electing to use the alternative dates and list the dates covered.
Expenses Paid and Incurred
According to the language in the CARES Act, expenses eligible to be forgiven had to be both paid and incurred during the eight-week covered period. The wording of this brought much confusion since many expenses might be paid during the period but not incurred, or incurred but not yet paid. The loan forgiveness application explains that the expenses must be both incurred (“earned” by the employee for purposes of payroll) and paid during the covered period – with a small exception. Expenses that are incurred during the covered period but not paid are eligible as long as they are paid within a certain time frame. Payroll costs that were incurred must be paid on or before the next regular payroll date. Non-payroll costs such as rent, utilities, and mortgage interest are also eligible as long as they are paid on or before the next regular billing date.
Employee-Owner Salary Limitations
Compensation paid to employee-owners, such as shareholder wages, guaranteed payments to partners, and self-employed earnings, are also eligible for PPP loan forgiveness. The loan forgiveness instructions make note of the limitations on these payments, which had not previously been explained. Employee-owner compensation during the covered period cannot exceed eight weeks of 2019 earnings, or $15,385, whichever is less.
Calculating Full-Time Equivalents (FTEs) for PPP
One of the more challenging aspects of the PPP loan is the forgiveness reduction for any drop in full-time equivalent employees (FTEs) during the covered period. In order to determine if the borrower reduced their FTEs, a computation of their base period is required. The base period for a non-seasonal employer is either January 1, 2020 to February 28, 2020 or February 15, 2019 to June 30, 2019. The borrower can use either time frame as the base period at their discretion. Seasonal employers can choose either of the aforementioned base periods or any 12-week period between May 1, 2019 and September 15, 2019.
Before this point, no official guidance had been provided on how to calculate FTEs for PPP loan purposes, and many borrowers were using the formula provided by the Affordable Care Act (ACA) to estimate their FTEs. The guidance released on May 15th provided FTE calculation instructions. The PPP application considers a 40-hour workweek as full-time, contrary to the ACA’s 30-hour workweek.
To calculate FTEs under this definition, the borrower may use two methods:
- Compute the average number of hours paid to each employee during the covered period, divide by 40, and then round to the nearest tenth.
- Alternatively, the borrower may use a simplified method by assigning a 1.0 to employees who work 40 hours or more and 0.5 to employees who work fewer than 40 hours a week. It is important to note that the same method for calculating FTEs must be used for both the base period and the covered period.
Rehire and Salary Restorations
Borrowers could be exempt from any FTE forgiveness reduction if a drop in their FTEs beginning February 15, 2020 through April 26, 2020 was restored by June 30, 2020. Therefore, even if the average FTEs during the covered period is less than the base period, the borrower may still be eligible for 100% loan forgiveness. For example, if a borrower had 100 FTEs on February 15th but laid off 20 FTEs by April 26th, as long as the company rehires 20 FTEs by June 30th, they should be exempt from the FTE forgiveness reduction.
As with the FTE reduction, if an employee’s pay is reduced by more than 25% during the covered period as compared to the first quarter of 2020, the borrower’s loan forgiveness could be reduced. Similar to the FTE exception, borrowers may be exempt from the salary/wage reduction if a decrease in average employee pay is restored by June 30th. The instructions provide a detailed method for determining if the exception applies based on the relevant dates and reduction amounts. More specifically, the wages and salaries are pared down to a “rate of pay” instead of comparing total pay during the eight-week covered period to 13 weeks from the first quarter. This computation provides a more accurate comparison to determining if any salary reductions actually took place.
Good Faith Rehire Efforts
Many borrowers were faced with tough decisions at the beginning of the COVID-19 Pandemic, especially those whose business were partially or fully shut down. Knowing that they could not afford to keep employees on payroll, they laid off or furloughed some or all of their staff. Many of those employees applied for and began receiving unemployment benefits and for some, this equated to more than their regular take-home pay. Other employees were not laid off but could not work due to lack of childcare or other health reasons. In any case, once companies were able to get their hands on the PPP loan funds, they were eager to bring employees back. Borrowers quickly found that some employees were not as eager to come back to work or give up their unemployment pay increase. Therefore, an additional FTE reduction safe harbor was set in place to provide reprieve to these borrowers who made a good faith effort to rehire employees.
The safe harbor provides that FTE reductions under certain circumstances do not reduce the loan forgiveness. In order for the safe harbor to apply in the case of rehires, the borrower must make a written offer to rehire the employee during the covered period and document the employee’s rejection of the offer. Additionally, if during the covered period an employee was fired for cause, voluntarily resigned, or voluntarily requested and received a reduction of hours, then the exception applies in these cases as well.
Payroll Cost 75% Requirement
Since lawmakers intended for the PPP loan proceeds to be used primarily for payroll costs, they quantified it with the expectation that 75% would be used for this purpose. Some interpreted this to mean that if a borrower did not use 75% of the loan proceeds in this way that the loan would not be forgiven at all. Others thought this was meant to be a reduction of the loan forgiveness off the top with the other reductions to follow. The instructions make it clear that neither of these assumptions is true, which may be a relief to many borrowers.
Instead, at the bottom of the forgiveness application are three potential forgiveness amounts to compute. The first is based on actual expenses less any FTE or salary reductions, the second is the full loan amount, and the third is the payroll costs gross-up for the 75% requirement. The loan forgiveness is the smallest of the three amounts.
For example, assume a loan amount of $100,000 with payroll costs of $74,000 and no FTE or salary reductions. The amount of forgiveness would be the lesser of $100,000 or $98,667 ($74,000/0.75). Assume the same facts except that the payroll costs were $80,000. The forgiveness amount would equal the lesser of $100,000 or $106,667 ($80,000/0.75), and therefore it would be fully forgiven.
How can Blue & Co. help?
Although the Loan Forgiveness Application provided clarification, we realize that borrowers may still need assistance and have more questions. Each borrower has their own individual set of circumstances, and the answers are not always black and white. It is important for borrowers to “get in front” of their loan forgiveness calculation and make adjustments before the end of the covered period if necessary.
We are here to help guide and assist borrowers through this process and help gather required documentation for your lender. If you have questions about your unique situation, please reach out to your Blue & Co. advisor.