Section 1102 of the CARES Act creates the Paycheck Protection Program (PPP), which is intended to provide funds for small businesses affected by COVID-19 to maintain their workforce. The loans are forgivable under Section 1106 of the CARES Act if the loan is used for permitted payroll, rent, mortgage interest, and utilities expenses and certain workforce and salary maintenance thresholds are met. To apply for the loans, employers must make a number of certifications, including that economic uncertainty due to COVID-19 makes the loan necessary to support ongoing business operations. Additional certifications are required to apply for loan forgiveness.
The roll out of the program has been marked by uncertainty over how key terms are being interpreted despite significant guidance being regularly released by the Small Business Administration (SBA) and posted on the Treasury Department’s website. This has made it challenging for some employers, especially those who have already conducted layoffs or furloughs, to determine if the loan will be forgiven, in whole or in part, and what steps should be taken to maximize forgiveness. Effective May 15, 2020, SBA released its Loan Forgiveness Application (SBA Form 3508) (Loan Forgiveness Application), providing some guidance on forgiveness issues. Employers should review the Loan Forgiveness Application carefully, along with the existing guidance that lays out how the loan amounts are calculated and how the proceeds can be used—all with an eye toward helping businesses incorporate the loans into their workforce planning decisions.
With the SBA changing its guidance frequently during the roll out of the program, sometimes in ways that do not clearly follow or that contradict the statutory text of the CARES Act itself (or interpretive guidance released thereafter), it is important to always confirm the latest guidance before moving forward with any decisions about participation in the program or use of the proceeds.
Who Can Apply?
Small businesses with 500 employees or fewer, including sole proprietorships, independent contractors and self-employed persons, 501(c)3 nonprofits, 501(c)(19) veterans organizations, or Tribal business concerns affected by COVID-19 may apply for a covered loan. Accommodation and food services businesses qualify if they employ 500 or fewer employees per physical location.
Businesses with more than 500 employees may be eligible if they meet certain existing size and revenue rules used by the SBA. In addition, businesses who currently have more than 500 employees may be eligible if their number of employees is fewer than 500 using the calculation rules discussed below.
Eligibility for businesses with related entities is determined using SBA affiliation rules as modified by the CARES Act. For more information on the affiliation rules applicable to PPP, see our Private Equity Alert.
Businesses must have been in operation on February 15, 2020 to be eligible to apply for a loan. In the FAQs , which, as of the date of this alert, were last updated May 13, 2020, SBA clarified that a change in the ownership of the business will not prohibit loan eligibility. If the acquiring business has maintained the operations of the pre-sale business, it may rely on the historic payroll costs and headcount of the pre-sale business for purposes of its PPP application, except where the pre-sale business applied for and received a PPP loan.
How Do I Calculate the Number of Employees?
This is one of the areas on which SBA guidance continues to conflict. On April 24, 2020, the SBA issued How-to-Calculate-Loan-Amounts for different types of entities. It directs employers to use their calendar 2019 payroll and benefit expenses. Both before that date and in its FAQs, however, the SBA has given most employers a choice of what time period to use “for the purpose of applying an employee-based size standard.” It appears that the SBA is permitting employers to use alternate calculations to make themselves eligible for PPP loans, even though one calculation method would yield more than 500 employees, provided that another permitted method yields fewer than 500 employees.
Determining Who Are Employees. For determining the 500-employee threshold, the term “employee” includes individuals employed on a full-time, part-time, or other basis. It also includes student employees, other than state or federal work study students. Business are required to include the employees of all its “affiliates,” including foreign affiliates, in their own count. Affiliates is a defined term under existing SBA regulations, which the CARES Act modified in some ways. The term includes entities controlled by the business or under common control with the business (see link above for more details on the affiliation rules).
Independent contractors of the business cannot be counted as “employees.” Rather, independent contractors may apply separately based on their own compensation and benefits expenses.
Alternative Counting Methods. Under the FAQs, the number of employees may be measured using any of the following methods: (1) average number of employees for the last 12 months; (2) average number of employees for 2019; or (3) average number of employees per pay period in the 12 completed calendar months before the loan application.
Seasonal businesses may use the average number of employees from February 15, 2019 or March 1, 2019 through June 30, 2019. Under regulations issued on April 27, 2020, they also can choose to use average total monthly payments for payroll during any consecutive 12-week period between May 1, 2019 and September 15, 2019.
Businesses that have been in operation for less than 12 months can use either their average monthly employees for January 1, 2020 through February 29, 2020 or the average number of employees for each of the pay periods the business has been operational.
It has been, at times, difficult to keep up with the evolving guidance. Accordingly, it appears that some lenders are still permitting employers to use only the 2019 average or only the last 12 months, rather than giving employers the option that the FAQs provides. Borrowers should consult their lenders to understand what documentation the lenders are requiring for the application, as the documentation likely will need to support the number of employees listed on the application.
Employees vs. Full-Time Equivalents (FTEs). In the FAQs, the SBA confirmed that the 500-employee threshold for the loan is based on total employees, not FTEs. Loan forgiveness, on the other hand, is based on FTEs, as discussed below.
Why Does the Calculation Method Matter?
Selecting the number of employees to include on the application is important, as it may impact eligibility for certain businesses. As discussed below, the Loan Forgiveness Application requires employers to list the number of employees at the time of the original application, as well as the number at the time of the Loan Forgiveness Application. The purpose of this requirement is unclear because loan forgiveness is based on FTEs, not employees, and different measuring periods can be used, at the election of the borrower, for determining the number of FTEs for loan forgiveness. It is possible, but by no means clear, that this information is intended to allow SBA to assess borrower eligibility given the changing guidance related to workforce count over the past several weeks.
It is worth noting that, although the FAQs permit the same periods to be used to calculate payroll costs for determining the amount of the loan, the guidance suggests that employers could use two different methods for determining the number of employees and the amount of payroll costs. This is particularly important for employers that already have done workforce reductions (prior to applying for the loan), as the time period selected for calculating payroll costs may determine whether they can use the proceeds in accordance with the program’s mandates. Employers with growing workforces, by contrast, may want to use the method that leads to the highest number so that they can use the proceeds to cover as much of their payroll costs as possible. This is discussed further below.
What are the Application Windows?
The deadline to apply for a PPP loan is June 30, 2020.
The FAQs define the period for purposes of determining payroll costs for loan forgiveness as the eight weeks beginning on the date the lender makes the first disbursement of the PPP Loan to the borrower, which must occur within 10 calendar days from the date of loan approval. The Loan Forgiveness Application gives employers some flexibility to align this period with their regular pay periods, as discussed below.
The CARES Act ends the period for which payroll and other costs can be covered on June 30, 2020. This appears to be an error because it allows loan to be approved until that date and would not allow borrowers who receive funds after the beginning of May the full eight weeks to use the loan proceeds. The Loan Forgiveness Application appears to correct this as it does not limit forgiveness to expenses incurred and paid before June 30, 2020, but instead focuses on the eight-week limits laid out in the Loan Forgiveness Application, described below.
What Must Borrowers Certify in the Loan Application?
In addition to obligations to answer questions within the application truthfully, an applicant must explicitly certify in good faith, among other things:
- that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant;”
- that “funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments, as specified under the Paycheck Protection Program Rule;”
- that the applicant understands that “if the funds are knowingly used for unauthorized purposes, the federal government may hold [the applicant] legally liable, such as for charges of fraud;”
- that the applicant will provide the lender documentation of the number of FTEs on the payroll as well as documentation for the permissible uses of the loan proceeds; and
- that the applicant has not received or applied for another SBA loan for similar reasons during the covered period.
Sole proprietors, independent contractors, and self-employed individuals must submit documentation, including payroll tax filings, Forms 1099-MISC, and income and expenses. For borrowers that do not have any such documentation, they must provide other supporting documentation, such as bank records, sufficient to demonstrate the qualifying payroll amount.
If PPP funds are used for unauthorized purposes, the borrower will be required to repay those amounts. Additional penalties will be charged if funds are knowingly used for unauthorized purposes. Further, the SBA fact sheet states, “if the proceeds are used for fraudulent purposes, the U.S. government will pursue criminal charges against you.”
Recent regulations and guidance by SBA in the FAQs are focused on whether borrowers, including those with access to liquidity, can make the required certification of necessity for the loan. Borrowers have until May 18, 2020 to repay the loan proceeds without facing penalties if they conclude that the loan was not “necessary” under the FAQs. The SBA will presume that borrowers with loans under $2 million made the certification in good faith. Borrowers with loans in excess of $2 million that have access to other sources of funds should review the emerging guidance on this issue carefully. SBA has also announced that it will review the files for all loans of $2 million or more (and other files when it deems appropriate) when they are submitted for forgiveness, further increasing the pressure on large borrowers to insure that they can satisfy the necessity certification. If SBA determines that the loan was not necessary, it will demand repayment and deem the borrower not eligible for forgiveness. If the borrower repays the loan, SBA will not pursue criminal or other penalties.
What Are the Loan Period, Interest Rate and other Terms of the Loans?
Applicants should view this as a loan program with the possibility, but not the guarantee, of forgiveness. Any loan amounts not forgiven will have a maturity of two years, with a one percent interest rate. Payments are deferred for six months, but interest does accrue during the deferral period. The loan is guaranteed by the federal government, so there is no requirement for a personal guarantee or collateral. In addition, the borrower is not subject to any loan fees and there is no prepayment penalty.
Assuming proper use of proceeds, loan amounts, including both principal and deferred interest, are 100 percent forgivable, subject to the limitations discussed below.
How is the Loan Amount Calculated?
Businesses can borrow a maximum of 2.5 times their average monthly payroll costs, up to $10 million. The SBA’s Interim Final Rule, as modified by the FAQs, provides the following steps for calculating payroll costs:
Step 1: Aggregate payroll costs (defined below) for employees whose principal place of residence is the United States. Most borrowers can choose to aggregate their payroll costs for either the 12 months before the loan application or calendar year 2019. Seasonal businesses may use average monthly payroll for February 15, 2019 or March 1, 2019 through June 30, 2019 or during any consecutive 12-week period between May 1, 2019 and September 15, 2019. Borrowers who were not in business from February 15, 2019 to June 30, 2019 may use their average monthly payroll costs for January 1, 2020 through February 29, 2020.
Step 2: Subtract any cash compensation paid to an employee in excess of $100,000 annualized. For independent contractors or sole proprietors, subtract any cash compensation earned in excess of $100,000 per year.
Step 3: Calculate average monthly payroll costs (divide the amount from Step 2 by 1).
Step 4: Multiply the average monthly payroll costs from Step 3 by 2.5.
Step 5: Add the outstanding amount of an Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020, less the amount of any “advance” under an EIDL COVID-19 loan (because it does not have to be repaid).
Payroll costs includes the following compensation and benefits paid to employees or on behalf of employees—
- the gross amount of salary, wage, commission, or similar compensation (presumably, this includes bonuses, although they are not mentioned in the statute, regulations or FAQs);
- payment of cash tips or equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate of such tips);
- payment for vacation, parental, family, medical, or sick leave;
- allowance for dismissal or separation;
- payment required for the provisions of group health care benefits, including insurance premiums;
- payment of any retirement benefit; and
- payment of State or local tax assessed on the compensation of employees.
For independent contractors and sole proprietors, includable payroll costs are the sum of payments of any compensation or income that is a wage, commission, income, net earnings from self-employment, or similar compensation and that is in an amount that is not more than $100,000 in one year, as prorated for the covered period. The following are expressly excluded from the payroll cost calculation:
- the cash compensation paid to an individual employee in excess of an annual salary of $100,000 including payments such as housing allowances, prorated for the period to be covered by the loan (i.e. amounts in excess of $8,333.33 per month). This includes any payments made to an employee, such as a housing allowance, but not contributions for retirement benefits or health care benefits paid on behalf of an employee;
- payments made by a business to its independent contractors;
- payroll, FICA and other federal taxes imposed or withheld from employee compensation (the FAQs explain that borrowers should not deduct federal taxes withheld from their payroll calculations, but also cannot add the employer tax amounts to their calculations);
- any compensation of an employee whose principal place of residence is outside of the United States;
- qualified sick leave wages for which a credit is allowed under section 7001 of the Families First Coronavirus Response Act (FFCRA); or
- qualified family leave wages for which a credit is allowed under section 7003 of the FFCRA.
What Can The Loan Be Used For?
The loan may be used to pay for the following costs incurred and paid during the eight-week (56 day) period after disbursement of the loan proceeds (“Covered Period”):
- payroll costs using the definition above;
- costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums;
- employee salaries, commissions, or similar compensation which is not in excess of $100,000 per year annualized;
- interest on mortgage obligations that were in place before February 15, 2020 (but not mortgage premiums);
- rent under lease agreements in force before February 15, 2020;
- utilities for which service began before February 15, 2020; and
- payment of interest on certain pre-existing debt obligations.
In addition, borrowers who received EIDL loans between January 31, 2020 and April 3, 2020 may use PPP loan proceeds to refinance those loans, and must refinance any amounts of the EIDL loan used to cover payroll costs.
According to the April 14 Interim Final Rule issued by SBA, cash compensation is limited to a maximum of $15,385 per individual over the eight weeks ($100,000 annualized). Under the Loan Forgiveness Application, this includes any amounts paid out for sick leave or vacation, as well as any severance amounts. In addition, under the Loan Forgiveness Application, cash compensation for owner-employees, general partners and self-employed individual (including independent contractors) can be no more than the amount they earned on average in eight weeks in 2019.
Utility costs includes water, gas, electric, phone, internet, and transportation. Transportation has not been defined; however, in the April 14 Interim Final Rule, which primarily addresses calculations for independent contractors and sole proprietors, SBA mentioned costs such as gas for a business vehicle. Therefore, it appears that gas for company-owned vehicles are included. It would not appear to extend to the cost of the vehicles themselves or maintenance or insurance. The Loan Forgiveness Application offers no further guidance on the subject of covered utilities.
The Interim Final Rules states that at least 75% of the loan proceeds shall be used to pay for permissible payroll costs. That suggested that there would be no forgiveness if a borrower does not meet that 75% threshold. However, the Loan Forgiveness Application calculations, discussed below, appear to permit partial forgiveness of the loan even when 75% of the loan proceeds are not spent on permissible payroll costs. It is important to note, however, that all use of the loan proceeds remains subject to the permissible uses of the loan and failure to do so may be considered an improper use of the loan proceeds, subjecting the borrower both to civil and criminal penalties.
What is the Timing of Costs Incurred and Paid?
Payroll Costs. Borrowers are eligible for forgiveness if they use the loan proceeds for “costs incurred” during the eight-week loan period. The Loan Forgiveness Application offers clarification on how to measure the period for costs incurred. For payroll costs, the Loan Forgiveness Application introduced the concept of an “Alternative Payroll Covered Period,” which borrowers may elect to use for payroll costs instead of measuring the eight weeks from the date of initial disbursement. The Alternative Payroll Covered Period is the eight-week period beginning on the first day of the first pay period following the initial loan disbursement date. For example, if the loan proceeds were disbursed on Monday, April 20, and the first day of the payroll period following disbursement is Sunday, April 26, the Alternative Payroll Covered Period would run from April 26 through June 20. This eliminates the need to run special payroll periods for employers with bi-weekly payroll or who receive the disbursement in the middle of payroll period. This Alternative Payroll Covered Period also applies to benefits costs. It does not apply, however, to non-payroll costs, such as mortgage interest, rent, and utilities.
The Loan Forgiveness Application clarifies that payroll costs are considered paid on the day that paychecks are distributed or on the date the ACH credit transaction is originated. Payroll costs are considered incurred on the day that the employee’s pay is earned. Payroll costs incurred but not paid during the last pay period of the Covered Period (or Alternative Payroll Covered Period) are eligible for forgiveness if paid on or before the next regular payroll date.
Eligible Non-Payroll Costs. The period for calculating rent, mortgage interest and utilities payments cannot be adjusted based on the Alternative Payroll Covered Period approach. However, there is added flexibility for including these costs as well. According to the Loan Forgiveness Application, a borrower has two options for calculating these expenses. It can include expenses paid during the Covered Period of the loan (the 56 days after initial loan proceed disbursement), or those incurred during the Covered Period and paid before the next regular billing date, even if the billing date is after the Covered Period. In other words, covered costs must be “paid or incurred” during the Covered Period.
While these calculation rules offer some additional flexibility to make sure that borrowers can use the money to pay for a full eight weeks’ worth of expenses, they do not permit prepayment of expenses, such as future rent, mortgage interest, utilities or other covered expenses that are not yet due (e.g., paying August’s rent in June).
What Documentation is Required for Loan Forgiveness?
The borrower must document the use of the proceeds and make additional certifications in order to apply for forgiveness, although the details of what will be required have been uncertain. The April 14 Interim Final Rule provides:
In addition to the borrower certification required by Section 1106(e)(3) of the Act, to substantiate your request for loan forgiveness, if you have employees, you should submit Form 941 and state quarterly wage unemployment insurance tax reporting forms or equivalent payroll processor records that best correspond to the covered period (with evidence of any retirement and health insurance contributions). Whether or not you have employees, you must submit evidence of business rent, business mortgage interest payments on real or personal property, or business utility payments during the covered period if you used loan proceeds for those purposes.
It also imposes additional requirements for the self-employed claiming lost profits.
The Loan Forgiveness Application adds more clarity to these documentation requirements. It specifies the documentation each borrower must submit with the Loan Forgiveness Application, as well as documentation that borrowers must maintain, but are not required to submit. With the application, borrowers must submit:
- PPP Loan Forgiveness Calculation Form (discussed below);
- PPP Schedule A (discussed below); and
- Payroll documentation verifying cash compensation and non-cash benefits payments made during the Covered Period (or Alternative Payroll Covered Period), consisting of:
- Bank account statements;
- Federal and state tax forms; and
- Payment receipts, cancelled checks, or account statements documenting employer contributions to employee health insurance and retirement plans that were included in the forgiveness amounts.
- FTE documentation showing:
- The average number of FTEs on payroll per month between February 15, 2019 and June 30, 2019;
- The average number of FTEs on payroll per month between January 1, 2020 and February 29, 2020; or
- In the case of seasonal employers, either of these periods or any consecutive 12 week period between May 1, 2019 and September 15, 2019.
- Non-payroll documentation verifying the existence of obligations/services prior to February 15, 2020 and eligible payments during the covered period.
Borrowers are also required to complete and maintain the PPP Schedule A Worksheet that is included in the Forgiveness Application. Table 1 of the Worksheet requires borrowers to compile a list of each individual employee’s cash compensation, average FTE, and salary or hourly rate reduction, if applicable. Table 2 requires a listing of each individual employee who received cash compensation of more than $100,000 in 2019. The Schedule A Worksheet has a FTE Reduction Safe Harbor section which must be completed, if applicable (discussed below). Borrowers must also maintain records showing any job offers and refusals, firings for cause, voluntary resignations, and written requests by any employee for reductions in work schedule. In addition, the instructions contain a worksheet on the wage reduction calculations and safe harbor (discussed below).
In addition to these specific documentation requirements, borrowers must maintain all documentation submitted with the PPP loan application, supporting the certifications made, and supporting material compliance with PPP requirements. All documentation must be maintained and available for inspection by SBA for six years after the date the loan is forgiven or paid in full.
How Does the Loan Forgiveness Work?
The details of how loan forgiveness will be calculated and subject to reduction has been one of the biggest areas of uncertainty. This lack of clarity has made it extremely difficult for companies who want to maximize their opportunity for loan forgiveness to plan workforce strategies for the coming weeks and months around rehiring laid off or furloughed employees, reducing salaries, conducting additional layoffs or furloughs, or hiring new employees.
The Loan Forgiveness Application addresses many of those questions. It includes instructions for completion and answers some of the most pressing questions about forgiveness. It includes the Loan Application Form, PPP Schedule A, and the PPP Schedule A Worksheet, borrower certifications (discussed below), and documentation requirements (discussed above). Borrowers are instructed to complete Schedule A and the Worksheet to compute eligible compensation for each employee, the number of FTEs for the covered period, and the applicability of forgiveness reductions and the savings provision. The Loan Forgiveness Application was released without contemporaneous guidance beyond the instructions contained in the application. As a result, some questions remain. The discussion below is based on what we have learned from the Loan Forgiveness Application, what appears in the CARES Act itself, and in the limited guidance on loan forgiveness provided so far by the SBA in the interim regulations and the FAQs. No forgiveness regulations have been issued as of the publication of this Alert. SBA has said that the decisions on forgiveness will be made by the lenders, further increasing the uncertainty as lenders may apply different interpretations.
Use of Loan Proceeds. PPP loans are 100% forgivable if all the proceeds are used for qualifying payroll and benefit costs (using the definitions above), and permitted mortgage interest (but not principal), rent and utility payments during the eight-week period following disbursement of the loan proceeds, provided that at least 75% of the proceeds are used for qualifying payroll and benefit costs during that period, as discussed below.
Cash Compensation. Cash compensation paid to an employee cannot exceed $15,385 during the Covered Period or Alternative Payroll Covered Period (the equivalent of annual pay of $100,000 for eight weeks) . That specifically includes wages, commissions, paid time off and severance. Bonuses are not mentioned but presumably would be included as well. Notably, except for owner-employees, general partners and self-employed individuals (including independent contractors), the Loan Forgiveness Application does not ask whether amounts paid during the Covered Period or Alternative Payroll Covered Period are more than they were previously. Rather, it is focused on reductions (discussed below). Nor does it ask about the schedule of payments. Presumably, this suggests flexibility for employers managing their workforces through this crisis in two ways. First, employers trying to incentive people to work should not be limited in their ability to provide hazard pay or make up for lost tips or commissions (subject to the cash compensation cap). Second, if employers need to lay off employees again at the end of the eight-week period, they should not risk losing forgiveness by paying those employees severance in a lump sum at the end of the period, so long as the employees’ total compensation, including the severance, does not exceed the cash compensation cap.
Deduction of EIDL Advances. If the borrower also received an EIDL loan advance up to $10,000, the SBA will deduct the amount of that advance from the forgivable amount of the loan.
What Factors Can Result in Reduction of Loan Forgiveness?
Workforce Measures. The amount of loan forgiveness is proportionally reduced if employers reduce their FTEs, or if they reduce employees’ salaries or wages by more than 25% (not including compensation for employees who earn more than $100,000) against certain pre-loan measures, unless those reductions are restored by June 30, 2020. Under the Loan Forgiveness Application, the salary or wage reductions are calculated first.
Compensation Reduction and Forgiveness. The amount of forgiveness is reduced by the amount of reduction in total salary or wages for each employee of more than 25% during the eight-week loan period compared to the pre-loan baseline wages and salary. The baseline is the salary and wages earned by the employee during the last completed calendar quarter before the loan period (i.e. first quarter 2020). Employees who earned the equivalent of $100,000 annualized ($8,333.33 per month) during any pay period in 2019 are not included in this calculation.
The Loan Forgiveness Application cleared up the confusion around how borrowers are to compare wages and salary during the eight-week loan period against wages and salary during the nearly 13 weeks of Q1 2020. Borrowers should compare the average annual salary (for salaried employees) or hourly rate (for hourly employees) during the Covered Period or Alternative Covered Payroll Period to the average salary or rate in Q1 2020. A decrease in loan forgiveness only occurs if that average salary/hourly rate for each employee is reduced by more than 25%. These calculations are done on an individual basis and the amount of loan forgiveness is reduced by the amount that each employee’s salary/hourly rate was reduced by more than 25%, unless the savings provision discussed below applies. The calculations of this reduction for salaried employees and hourly employees are detailed separately in the Loan Forgiveness Application.
Notably, although not specifically defined, the Loan Forgiveness Application’s calculation method suggests that only base salary or hourly wage rate will be considered for calculating reductions, as opposed to a comparison of total cash compensation. For employers that provide significant amounts of compensation through bonuses, commissions, or other revenue sharing measures, this distinction is critical and eliminates the problem posed by bonuses or commissions paid in Q1 2020 that could have inflated compensation for that time period. Note, however, that the Loan Forgiveness Application does not address this issue directly, nor does any guidance by SBA to date.
FTE Reduction and Forgiveness. The amount of forgiveness will be reduced by multiplying the otherwise forgivable loan amount (i.e. the amount spent on permissible expenses less any EIDL advance) by the proportion of employment loss. Employment loss for forgiveness purposes is based on FTEs, not workforce headcount. Employment loss is calculated by determining the quotient of average number of FTEs each pay period during the eight-week period divided by pre-loan FTEs. To calculate its pre-loan FTEs, an employer can use either (a) its average number of FTEs from January 1, 2020 to February 29, 2020, or (b) its average number of FTEs from February 15, 2019 to June 30, 2019. Under the Loan Forgiveness Application, seasonal employers can use either of these time periods or any consecutive 12-week period between May 1, 2019 and September 15, 2019 to measure their FTEs. For example, if the resulting quotient is 90%, the employer’s loan forgiveness is reduced by 10% (unless adjusted based on the savings provisions discussed below).
The Loan Forgiveness Application provides a long-awaited explanation on how to calculate FTEs. For each employee, take the average number of hours paid per week, divide by 40, and round the total to the nearest tenth. The maximum for each employee is capped at 1.0. Alternatively, a simplified method is to assign a 1.0 for employees who work 40 hours or more per week and 0.5 for employees who work fewer hours.
Once the employer calculates FTEs during the Covered Period or the Alternative Payroll Covered Period, they are compared to determine if the total amount of potential forgiveness is reduced. For example, if an employer’s FTEs are 50% lower during the eight-week loan period than they were during the selected pre-loan measuring period, the amount of loan forgiveness is reduced by 50%, subject to the additional reductions and the savings provisions described below. Because of the significant impact that it may have on determining the amount of forgiveness, employers should carefully consider how to structure both any changes in their workforce related to the loan period and which measuring period to choose. For example, it appears that employers could decide to consolidate part-time positions into full-time positions to maintain or increase their number of FTEs, even as they reduce total headcount and, potentially, benefit costs. From the text of the CARES Act, and the calculation method in the Loan Forgiveness Application, doing so would not appear to trigger reduction in forgiveness.
Notably, in the FAQs, SBA announced that it would not reduce loan forgiveness amounts for borrowers that have laid off employees and offered to rehire them at the same wage rate and number of hours, but the employee refuses the job offer. The Loan Forgiveness Application states that employees do not count as an FTE reduction if they: (i) refuse a written offer to return, (ii) voluntarily resign, (iii) are fired for cause, or (iv) voluntarily requested and received a reduction in hours. In each of these cases, the employee does not count as an FTE only if the position was not filled by a new employee. Note that this only provides employers with relief on the reduction in FTEs -- it does not allow borrowers to count what the excluded employee would have earned as salary or wages toward the compensation forgiveness reduction component.
In an April 27 webinar, the Deputy District Director for the SBA in New York stated that it is the number of FTEs, not the identity of the employees, which matters for purposes of calculating forgiveness. So, hiring different employees to replace those who were laid off or left on their own should not result in a decrease in forgiveness amounts. Further, according to the information provided in the webinar, nor is there any requirement that the employees actually perform work during the loan period. The purpose of the PPP loans is to keep people on payroll and off unemployment so paying people not to work is acceptable. Be aware that these were statements made by a single official in a webinar, not official pronouncements of the SBA, so we cannot rely on them, but they are do provide insight and there is nothing in the Loan Forgiveness Application that suggests otherwise.
The reductions in potential forgiveness based on decreased FTEs and on pay reductions are cumulative, which can limit employer options to account for costs that are not covered by PPP while facing revenue reductions. For example, businesses that are struggling to pay for insurance costs, inventory, and other fixed and variable expenses may need to reduce expenses that PPP loans do not cover. Yet, seeking to reduce those expenses by reducing employee compensation or headcount may threaten the ability to receive loan forgiveness and, therefore, add to the financial strain on the business.
What “Savings Provisions” Can Borrowers Use to Ameliorate Forgiveness Reductions?
Savings Provision for Reduction Window. The CARES Act includes a “savings” provision that allows businesses that conducted layoffs or furloughs or salary reductions for one or more employees between February 15, 2020 and April 26, 2020 (the reduction window) to receive the full amount of forgiveness to which they would otherwise be entitled provided that: (i) any reduction in FTEs that occurs during the reduction window is restored by June 30, 2020 to at least to the number of FTEs employed on February 15, 2020; and/or (ii) the reduction in average annual salary or hourly wage for each employee compared to February 15, 2020 has been restored by June 30, 2020.
The Loan Forgiveness Application makes clear that reductions occurring after April 26, 2020 cannot be “saved,” which is consistent with the expectation that PPP funds will be use to preserve employment and compensation for employees. Notably, the Loan Forgiveness Application contains separate worksheets for employers to determine if they qualify for these so-called “safe harbors” against reductions in loan forgiveness and allows employers to qualify for them separately. In other words, employers can qualify for one or the other or both.
Borrowers are exempt from the reduction in loan forgiveness based on FTE if both of the following conditions are met: (1) the reduction in FTEs occurred between February 15, 2020 and April 26, 2020; and (2) the FTE levels are restored by June 30 to the FTE levels in the pay period including February 15, 2020. Notably, this portion of the Loan Forgiveness Application only asks for FTEs on June 30, 2020. Thus, the Loan Forgiveness Application could be interpreted to suggest that employers may lay off or furlough employees during the reduction window and restore them on June 30, 2020 to satisfy the savings provision, even if employees have only been employed for one day.
Borrowers are exempt from the reduction in forgiveness for salary/hourly wage reductions that occurred between February 15, 2020 and April 26, 2020, if wage levels are restored by June 30, 2020. The calculation of whether this safe harbor applies and, if not, what impact it has on loan forgiveness is a multi-step process:
- First, the Loan Forgiveness Application requires borrowers to determine if there was a reduction of more than 25% in the salary or wages of any employee (who earned less than $100,000 annualized in 2019, as discussed above). If no employee had their average salary or hourly wage reduced by more than 25%, there is no reduction and nothing more needs to be done.
- If one or more employees did suffer such a reduction, the employer next compares that employee’s average annual salary (for salaried employees) or hourly wage (for hourly employees) on February 15, 2020 with the average for that employee during the February 15 to April 26, 2020 reduction window. If the amount during the reduction window is the same or greater, the next step is to calculate the amount of the reduction in forgiveness because the Safe Harbor does not apply.
- If the average annual salary or hourly wage during the reduction window is less than it was on February 15, 2020, it is next compared to the average annual salary or hourly wage on June 30, 2020. If the June 30 average is greater than or equal to the average on February 15, 2020, the Safe Harbor has been satisfied, and there is no reduction in forgiveness. If not, the next step is to calculate the amount of the reduction in forgiveness following the separate instructions in Loan Forgiveness Application for salaried and hourly employees.
Note that there is no minimum amount of reduction that disqualifies an employer from taking advantage of the Safe Harbor for any given employee if that employee suffered a reduction in salary/wage rate that triggers the loss of forgiveness, and their average annual salary or hourly rate on June 30, 2020 is less than it was on February 15, 2020.
Open Questions. The Loan Forgiveness Application has resolved a number of areas of uncertainty, but, without further guidance, open questions remain, including the following:
- Can the benefit contributions for employees who are furloughed (i.e. employed in a non-paid status but receiving health care and other benefits) be included in covered payroll costs?
- For the employee’s average annual salary or wage rate on June 30, 2020, does the employee actually have to be paid that amount by June 30, 2020, or just that the employee’s wage rate must be restored by that date, even if they have not actually earned the money? If they must have been paid that amount, over what period of time?
- Is an employer exempt from the salary reduction calculations if it brings in different employees at whatever wage or salary rates it wants because the salary reduction restoration only applies if an individual remains employed and suffers a pay cut?
- If an employer—such as a school or an employer that operates a school-year program—does not layoff or furlough employees during the reduction window, and they do not resign or are terminated for cause, but the employer nevertheless loses a significant portion of its employees during the eight-week loan period based on the scheduled end of employment when the academic or program period ends, will it still have its amount of forgiveness proportionally reduced?
With the eight-week loan period used to determine the amount of forgiveness beginning when the loan proceeds are received, most employers applying for PPP loans have already made critical workforce decisions. As a result, the guidance gleaned from the Loan Forgiveness Application, while crucial, may be too late to play a role in some of these decisions as they relate to loan forgiveness.
Can You Provide Examples of How Forgiveness Works?
In order to achieve 100% forgiveness of the loan under the Loan Forgiveness Application, employers must do all of the following: (1) use at least 75% of the total amount of the loan on qualifying payroll and benefit costs during the Covered Period or Alternative Payroll Covered Period, (2) spend the remaining loan proceeds of not more than 25% of the total loan amount on qualifying rent, mortgage interest and utility payments during the Covered Period, (3) not have their forgiveness reduced based on reductions in FTEs or employees’ wages or salaries, discussed above, and (4) not have received an EIDL advance. Not satisfying any of these requirements will result in reduction of the loan forgiveness amount.
Specifically, the Loan Forgiveness Application provides that the forgiveness amount is the lesser of: (1) the total amount of the loan; (2) the amount spent on qualifying payroll costs during the Covered Period or Alternative Payroll Covered Period divided by 0.75 (to calculate the 75% payroll cost threshold); or (3) the total amount spent on qualifying payroll and benefit costs, as well as rent, mortgage interest and utilities during the eight-week loan period, less the amount of reductions in FTEs and employees’ wages or salaries. The following scenarios, each assuming a loan of $100,000 without an EIDL advance, demonstrate the impact of how the loan proceeds are spent and workforce decisions made by the employer during the loan period:
- The borrower spends $75,000 on payroll costs, the remaining $25,000 on mortgage interest, rent and utilities and did not reduce its FTEs or reduce salaries or wages. The borrower is eligible for forgiveness of $100,000.
- The borrower spends $65,000 on payroll costs, the remaining $35,000 on mortgage interest, rent and utilities and did not reduce its FTEs or reduce salaries or wages. The borrower is eligible for forgiveness of $86,666 because the non-payroll expenses cannot be more than 25% of the total amount for which forgiveness is sought ($65,000/0.75 = $86,666).
- The borrower spends $65,000 on payroll costs, $10,000 on mortgage interest, rent and utilities and did not reduce its FTEs or reduce salaries or wages. The borrower is eligible for forgiveness of $75,000 because that is the total amount spent on forgivable expenses during the loan period and the non-payroll expenses are below the 25% cap.
- The borrower spends $65,000 on payroll costs, $10,000 on mortgage interest, rent and utilities and reduced its FTEs by 10%. The borrower is eligible for forgiveness of $67,500 because that is 90% of the amount spent on forgivable expenses during the loan period.
What Certifications are Required for Forgiveness?
An authorized representative of the borrower must make several certifications on the Loan Forgiveness Application:
- The amount requested for forgiveness was (1) used to pay costs eligible for forgiveness, (2) includes all applicable reductions due to decreases in FTEs and salary/hourly wage reductions, (3) does not include non-payroll costs in excess of 25% of the amount requested, and (4) does not exceed eight weeks’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner, capped at $15,385 per individual.
- All payments for eligible payroll and non-payroll costs have been accurately verified. This includes an acknowledgement that the federal government may pursue recovery of loan amounts and/or civil or criminal fraud charges if the funds were knowingly used for unauthorized purposes.
- All required documentation has been submitted, and that the information provided in the application and supporting documents is true and correct. This section includes an acknowledgement that that making a false statement to obtain forgiveness is punishable under the law, including 18 USC 1001 and 2571 by imprisonment for up to five years and a fine up to $250,000; under 15 USC 645 by imprisonment for up to two years and a fine up to $5,000; and, if submitted to a Federally insured institution, under 18 USC 1014 by imprisonment of up to thirty years and a fine up to $1,000,000.
- SBA may request additional information for evaluating eligibility the PPP loan and for forgiveness, and that failure to provide such information may result in a determination that the borrower was ineligible for the loan or a denial of the Loan Forgiveness Application.
The application representations and certifications on page 4 of the Loan Forgiveness Application concludes with the following statement: “The Borrower’s eligibility for loan forgiveness will be evaluated in accordance with the PPP regulations and guidance issued by SBA through the date of this application. SBA may direct a lender to disapprove the Borrower’s loan forgiveness application if SBA determines that the Borrower was ineligible for the PPP loan” (emphasis added.) The highlighted statement appears to conflict with SBA FAQ 17, which provides, in part, that “Borrowers and lenders may rely on the laws, rules, and guidance available at the time of the relevant application,” which presumably includes eligibility rules and guidance.
When Will We Know More?
SBA was required to issue regulations and guidance on loan forgiveness by April 26, 2020, but we have not seen detailed rules to date other than the newly-issued Loan Forgiveness Application. As a result, it is not clear when or if they intend to issue regulations on forgiveness. Updates to existing FAQs have been posted on the Treasury Department’s website on a frequent basis, so additional guidance may come first in that form, although there is no way to predict when that will occur. Given the program deadlines, it seems clear that definitive (final) guidance on open questions will not be available for borrowers before they use loan proceeds.
