Now how do you spend the money so as to achieve the maximum amount of forgiveness? And not spend the money that will cause you to be liable for fraud. Please note that this discussion is only on the PPP loan program, and these rules do not apply to the SBA Economic Injury and Disaster Loans (EIDL).
The rule for the PPP loan program is that you must spend the money in a way that is Authorized, which includes a fixed proportion of no less than 75% Forgivable payroll costs, and up to 25% in Forgivable and Non-Forgivable other costs. This results in four groups, or buckets, of money. Additionally, even if spent this way, there are also two additional tests (employee compensation and count) that can be applied to reduce the forgiven amount, and there is an 8-week time limit to spend the funds for any forgiveness to apply. And there are special adjustments to these rules for seasonal businesses, but that will be the subject for another time. You will see there are some critical elements that you must do to keep from having to pay this loan back.
Probably the most contested and subject to change element today is the time limit. All of the funds for the PPP loan program that can be forgiven must be spent in an 8-week period. However, that 8-week period does not start on May 1. It starts the day that the PPP loan funds are deposited to your bank account. As an example, I have a client who received the deposit of PPP loan funds on April 23rd. His 8-week period began on April 23rd. The controversial part is that his state did not allow his business type to open until May 9. So, he has a more compressed window of time to spend funds within.
Now let’s get to the four buckets: (1) Authorized and Forgivable Payroll Costs, (2) Authorized and Forgivable Other Costs, (3) Authorized Non-Forgivable Costs, and (4) Unauthorized Costs.
Payroll costs have been specifically defined for this by both statute and regulation. You must spend 75% of the PPP funds on these payroll costs. Payroll costs include (1) Gross payroll and any other form of cash payments to the employee before any deductions or withholdings including wages, commissions and tips; (2) Any paid sick, medical, family vacation, or other form of leave except those that will be reimbursed by the IRS under the Families First Coronavirus Response Act; (3) payment for the provision of employee benefits for group health coverage (4) State and local employment taxes on the payroll paid by the employer, but not federal payroll taxes; and (5) Owner compensation and distributions.
Please note that payroll costs do not include (a) any compensation of an employee who lives outside of the United States; (b) compensation of an individual employee in excess of an annual salary of $100,000, or more than $15,385 during the 8-week time limit; (c) federal employment taxes imposed or withheld between February 15 and June 30 of 2020; and (d) qualified sick and family leave wages under the Families First Coronavirus Response Act that will be refunded to the employer by means of a tax credit.
Owner compensation and distributions have been capped at 8/52nd of your 2019 net profits up to $100,000 per the tax return. SBA has determined that this cap is intended to keep owners from disbursing all the loan proceeds to themselves. So if your 2019 tax return showed a profit of $65,000, owner distributions would be capped at $10,000 [ $65,000 x 8 / 52 ]. If your 2019 tax return showed a profit of $120,000, your owner distributions would be capped at $15,385 [ $100,000 x 8 / 52 ].
There is currently only one exception carved out in the statute that allows an employee to be paid more than $15,385 in cash during the 8-week time limit, and that is for the bona fide tip employee under the Fair Labor Standards Act. I have not yet seen any regulatory guidance on this matter, but we are currently interpreting this statute that we can ignore the cash tip income for the purposes of the $15,385 limit.
These costs are authorized to use PPP loan funds and are forgivable costs. You are only authorized to spend up to 25% of the PPP loan funds on these costs, and costs in excess would likely be deeded part of the fourth bucket of Unauthorized Costs, which must be avoided. These costs include (1) certain non-cash employee benefits; (2) certain mortgage interest payments; (3) certain rent payments; and (4) certain utility payments. We’ll take each in turn.
Non-cash employee benefits include (a) costs related to the continuation of group health care benefits during periods of leave, insurance premiums, and for the provision of employee benefits for group health coverage that wouldn’t qualify as a Payroll Cost above; (b) the employer’s contribution to any type of defined benefit plan (such as a pension plan) or a defined contribution plan (such as a SEP IRA); (c) the cost of a housing stipend or allowance; or other forms of fringe benefits to the employees. It appears from the regulations that you must have been able to claim a deduction for the cost of the benefit in the 2019 tax return, so now is not the time to institute a new fringe gym membership.
Certain mortgage interest payments include the interest on a mortgage obligation for any real property (such as a warehouse) or personal property (such as a vehicle or equipment loan) incurred before February 15, 2020, so you cannot use the PPP loan funds to buy more equipment. Principal payments are not an allowed use of the PPP loan funds, only the interest portion. You also cannot prepay any interest, only the amount currently due may use PPP loan funds. Only the portion that was deductible on the 2019 tax return may used PPP loan funds. For many businesses, this is all of the interest expense. However, for a sole proprietor it would only be the business portion of the interest that would be deductible. For example, if the personal use of a vehicle is 30%, then only 70% of the interest on the vehicle loan would qualify for PPP loan funds.
Certain rent payments include business rents pursuant to a lease in force before February 15, 2020, so you cannot use the PPP loan funds to lease a new office space or lease new equipment. The lease can be for real property (such as an office lease) or personal property (such as a car lease). Again, only the extent to which the lease was or could have been deductible on the 2019 tax return qualifies, which will likely only impact sole-proprietors.
Certain utility payments have a slightly broader definition than some may anticipate. Of course, it includes the traditional water, electric and trash costs. It also includes internet service and the cost of gasoline or diesel for your business vehicles. Again, it has to be an expense that you claimed or were entitled to claim on the 2019 tax return.
These costs are authorized for the use of PPP loan funds, but the spending of the funds will not result in forgiveness of the PPP loan funds. Also, these costs count toward the 25% limit on the overall use of the PPP loan funds. There are only two items here, but keep in mind that one is non-discretionary and will impact the majority of PPP loan recipients.
The first of these costs is the interest payment on debts incurred before February 15, 2020 that are not secured by real or personal property. This could be a line of credit, credit cards, hard money or pay-day loan, or other unsecured signature-type debts. The interest, but not principal, portion of this payment is allowed for the PPP loan funds. However, it will not count toward the forgiveness total, and you will have to repay this portion back under the terms of the PPP loan.
The second of these costs however is much more likely to impact most PPP loan recipients. If you also were approved for an SBA EIDL loan anytime between January 1, 2020 and April 3, 2020 (even though you may not have received the funds for some time afterward), then up to the first $10,000 of that loan was a grant and forgiven. You must refinance the forgiven portion of the EIDL loan with the PPP loan. So if you received a $5,000 EIDL loan and a $25,000 PPP loan, then you must refinance the $5,000 forgivable EIDL loan with the PPP loan. As a result, $5,000 of the PPP loan will be used and apply to the 25% cap, meaning that you will only have $1,250 for all the Type 2 expenses in this example. And you will have to repay the $5,000 over the terms of the PPP loan.
Why is this? Essentially, the government wants to only grant forgiveness through one loan program or the other. Therefore, if you have already received up to $10,000 of loan forgiveness with the EIDL loan program, you will not receive up to $10,000 of loan forgiveness with the PPP loan program as well.
This covers any costs that do not fit in the other three buckets. Any funds spent here are not authorized to be used for the PPP loan program. SBA’s First PPP Interim Final Rule specifies that PPP loan funds used for unauthorized purposes will result in the SBA requiring repayment of the funds, and some liability for charges of fraud. Because this is a government loan program, you cannot use the funds for unauthorized purposes.
Sometimes, unauthorized is a more intentional act, such as using the PPP loan funds to buy a vehicle. But it can also be unintentional, such as spending more than 25% of the PPP loan funds on non-Payroll Costs. For these reasons, we have recommended that the PPP loan funds be segregated into a separate bank account to ease tracing and limit misuse.
Employer received a $100,000 PPP loan deposit and a $10,000 EIDL loan deposit. The 2019 tax return reported a $65,000 profit, so the cap on owner compensation is $10,000 for the eight-week period. Payroll costs consist of $9,230 of weekly payroll for 8 weeks ($73,840), state payroll taxes of $2,215, owner’s compensation of $10,000. Total of the bucket 1 payroll costs, $86,055; or 86% of the PPP loan funds.
The EIDL $10,000 loan forgiveness comes off the top as a bucket 3 cost. Between the EIDL refinance and the payroll costs, $96,055 has been spent of the PPP loan funds. That leaves $3,945 for all the bucket 2 costs which include rent, utilities, and the employer match on the SEP IRA.
All of that leaves us with $90,000 spent on forgivable costs, and $10,000 to be repaid because of the EIDL loan. Are we all done? Not quite.
The amount of forgiveness is reduced based on the percentage of reduction from the average full-time equivalent employees employed during March 1, 2019 to June 30, 2019. For our example, let us assume that the average full-time equivalent employee count for that period of 2019 was 8 people. But the business was only able to lure 5 people to return to work with the promise of a higher salary. As a result, the forgiveness of the PPP loan available to the business is reduced by 37.5%. So instead of $90,000 of forgiveness, only $56,250 is forgiven and the balance has to be repaid according to the terms of the loan.
There is some relief to this rule however, which is critical to complete. SBA has announced they intend create a rule that allows an employer to exclude some employees from the count. If an employer has made a good faith, written offer to rehire an employee for the same salary or the same hourly wage and hours, and that employee has rejected that offer and the rejection is documented, then that employee could be excluded from the employee count. This is also adjusted for seasonal businesses.
The amount of forgiveness is reduced based on the percentage of reduction of employee compensation greater than 25%. This means that employee pay must be at least 75% of the prior quarter (January 2020 to March 2020), and to the extent that it is lower than 75%, the loan forgiveness is also reduced. People who were paid more than $100,000 annually in 2019 are excluded. This is adjusted for seasonal businesses.
1 – Be clear about what your individual, actual 8-week window to spend is.
2 – You may need your 2019 income tax returns completed to determine the limit of allowed owner compensation, and to apply for the forgiveness.
3 – Prepare written offers to rehire any furloughed employees and document any rejections.
4 – Be clear what your minimum qualified payroll costs have to be to hit the 75% used for payroll costs requirement and at least 75% of the prior quarter requirement.
5 – Adjust your other costs by the refinance of the EIDL loan if you received it, as this is a non-discretionary element and will consume some of your remaining 25%.
This is an evolving program, so these are the currently existing authorities that we referred to in preparing this. As new ones emerge, the contents of this article may or may not continue to be accurate.
Of course, nothing in this article should be considered tax or legal advice, but a general discussion about tax and legal topics that may or may not apply to you.