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How does Loan Forgiveness Work in a PPP Loan?

April 28, 2020

How does Loan Forgiveness Work for a PPP Loan JPS CPA April 28 2020

On March 27, 2020, President Trump signed into law the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES Act or the Act). Of the $2.2 trillion in stimulus, $349 billion was allocated for Paycheck Protection Program loans (PPP). On April 24, 2020, the President signed the Paycheck Protection Program and Health Care Enhancement Act, which amends the CARES Act. Among other things, the Amendment increased the funding for PPP loans from $349 billion to $659 billion.

Now that the first round of funding has happened and the second round is underway, questions are coming up about how the loan forgiveness portion of the PPP works. It is worth noting that many unanswered questions remain. This article will outline in a question and answer format how the loan forgiveness appears to work based on the information that is currently available. Section 1106 of the CARES Act addresses loan forgiveness, and the SBA has provided a small amount of additional guidance.

I have seen the term “covered period” mentioned. What is the “covered period”?
The Act states that the “covered period” is the period that begins when a business receives the loan proceeds and ends 8 weeks from that date. Note that this “covered period” differs from the “covered period” for determining the PPP loan amount.

What costs can the loan proceeds be used for in order to get loan forgiveness?
The Act states that during the “covered period” the sum of the following “costs incurred and payments made” will be eligible for forgiveness:

  • Payroll costs,
  • Interest payments on a mortgage that was incurred before February 15, 2020,
  • Lease payments under a lease agreement that was in place before •  February 15, 2020,
  • Utility payments including electricity, gas, water, transportation, telephone or internet service for which service began before February 15, 2020.

What are payroll costs?
Payroll costs include the following:

  • Salary, wage, commission or similar compensation, limited to $100,000 per employee, computed to be ($100,000 ÷ 52 weeks = $1,923.07 per week x 8 weeks = $15,384.61 for the 8-week period);
  • For a partnership or LLC, payroll costs also include guaranteed payments to a partner and also the partner’s share of the income from the partnership subject to self-employment tax, limited to $100,000 for each partner;
  • For a self-employed taxpayer, payroll costs include any payroll costs paid to employees and the net self-employment income reported on a 1040 Schedule C, subject to the $100,000 limit;
  • Payments for cash tips or equivalent;
  • Payment for vacation, parental, family, medical or sick leave;
  • Payment for dismissal or separation;
  • Payments required for the provisions of group health care benefits, including insurance premiums;
  • Payment of any retirement benefit; and
  • Payment for State or local tax assessed on the compensation of employees.

Payroll costs do not include:

  • Compensation of an individual employee, self-employment income or income of a partner in a partnership in excess of $100,000, prorated;
  • Federal unemployment taxes, Railroad Retirement Taxes or Federal income taxes. Further guidance will be required, but withholding taxes are neither subtracted nor added to compute payroll costs; gross payroll is used;
  • Compensation to an employee whose principal place of residence is outside of the United States;
  • Payments to independent contractors (1099 workers); or
  • Qualified sick leave wages for which a credit is allowed under section 7001 of 7003 of the Families First Coronavirus Response Act.

I understand that payroll is limited to $100,000 per employee, but what about the other payroll-related costs?
Recent guidance from the SBA clarified that the $100,000 compensation limit applies to cash compensation, salary and wages only. Additional payroll costs for retirement plan payments, payments for group health care and State and local taxes imposed on compensation may be added to the $100,000 in computing total payroll costs.

What does “costs incurred and payments made” mean? Do I have to actually make the payment?
The Act states that forgiveness is available for “costs incurred and payments made during the covered period.” This is an area that could create problems for businesses, depending on how this is ultimately interpreted.

Here is an example of how this could be problematic.

Let’s say that a company received the PPP loan proceeds on April 6 and had a payroll on April 7. The April 7 payroll was for the previous week. The cost was incurred the previous week before the “covered period” began, but it was actually paid during the “covered period.” So, was the “cost incurred and payment made” in the covered period?

As another example, assume that a company received the PPP loan proceeds on April 6. The 8-week covered period would end on May 25. Payroll was made on May 26 for the previous week. In this case, the cost was incurred during the “covered period”, but the payment was made outside the “covered period.”

The bottom line here is that we need further guidance.

I heard that no less than 75% of the loan amount has to be spent on payroll costs to get any debt forgiveness. Is this true?
Recent SBA guidance requires that of the costs eligible for forgiveness, 75% have to be for payroll costs and 25% for interest, utilities and rent combined. So, the loan will only be forgiven to the extent that no less than 75% of the costs are used for payroll, and a maximum of 25% is spent on other qualifying costs.

Here is an example that might help.

Assume that a company received a PPP loan in the amount of $100,000. The company incurred payroll costs during the “covered period” in the amount of $50,000 and incurred $40,000 for interest, utilities and rent combined. Assume further that the employee count didn’t change (more on that later). The company spent the $90,000 on costs that qualify for forgiveness. However, because of the 75/25 rule, the total forgiveness would be limited to $66,667 ($50,000 ÷ .75 = $66,667). This would be $50,000 for payroll costs and $16,667for the total of rent, utilities and interest.

In the above example, the company had to incur and pay at least $75,000 in payroll costs and no more than $25,000 in rent, utilities and interest combined to achieve full debt forgiveness. Because of the 75/25 rule, full forgiveness will be difficult for many companies to achieve unless they have increased their payroll costs during the covered period.

If a company laid off or furloughed employees over the past few months, does that impact the amount of the loan that can be forgiven?
Yes, a reduction in full-time equivalent employees (FTE) can decrease the amount of the PPP loan that is forgiven. In addition, to determining the costs eligible for forgiveness and then apply the 75/25 rule discussed above, we also have to consider the impact on changes in FTEs of a company to determine the ultimate amount that is eligible for forgiveness.

To make the determination of the impact of employment on the forgiveness, do the following:

  1. Determine the average number of FTEs per month for the 8-week period.
  2. Determine the average number of FTEs per month employed during the period February 15, 2019 through June 30, 2019; or
  3. Determine the average number of FTEs per month during the period January 1, 2020 through February 29, 2020.
  4. Divide the result of Step 1 by the smaller of the result of Step 2 or 3.

Let’s try an example. Assume the following:

  1. Average FTEs of 15 for the covered period (Step 1);
  2. Average FTEs of 22 for Step 2 (2/15/19 – 6/30/2019);
  3. Average FTEs of 20 for Step 3 (1/1/20 – 2/29/20);
  4. PPP loan amount of $100,000; and
  5. Eligible forgivable costs (payroll, rent, utilities, interest) incurred of $90,000.

To determine the forgiveness, you start by dividing the result of 1 above by the lesser of 2 or 3 as follows:

15 ÷ 20 = .75

You would then multiply the forgivable costs incurred by the result of the previous step:

$90,000 x .75 = $67,500

In this example, the total amount of the $100,000 loan eligible for forgiveness is $67,500.

The FTEs are determined per pay period. To date, there has been no guidance on how to compute FTEs. It is possible that an employee working at least 30 hours per week would be considered a FTE. In that case, for part-time employees for each week, you would take the hours they worked divided by this 30-hour threshold.


If I rehire laid off or furloughed employees, does that help with the forgiveness?
Yes, any reduction in FTEs during the period of February 15, 2020, and April 27, 2020, that are fully restored by June 30, 2020, would be treated as being FTEs for the full covered period. It should be noted that the Act states “fully” restored. While it is not clear, the presumption is that any rehires would improve the forgiveness computation. We remain hopeful that further guidance will be issued.

Using the previous example, let’s assume that 5 employees were rehired by June 30, 2020. The forgiveness would computed as follows:

20(15+5) ÷ 20 = 1

We would then multiple this result by the eligible forgivable costs:

$90,000 x 1 = $90,000

In this example, the costs eligible for forgiveness would be $90,000.

Is there any impact if I reduced compensation of employees instead of furloughing or laying off employees?
There is a reduction in the loan forgiveness if wages are reduced for any one employee by more than 25%. We will use the following example to demonstrate the computation:

Assume that one employee has a normal annual salary of $60,000 and received this level of compensation for the first quarter of 2020 and that no other employee had a reduction in compensation. Further, during the covered period, the salary for this employee decreased by $20,000 to $40,000. The following computation would be required:

$60,000 x 25% = $15,000

After computing the 25% limit on compensation reduction, we would compare that to the actual level of compensation reduction for the covered period:

$20,000 – $15,000 = $5,000

In this example, the eligible forgiveness would be reduced by $5,000, the amount by which the reduction exceeded 25% of the employee’s pay.

When and how do I apply for loan forgiveness?
While we have seen no guidance addressing the specific time for requesting loan forgiveness, presumably you could apply after the covered period (8 weeks following receipt of the loan proceeds). This would be done by completing an application and submitting it to the lender. The Act states that a forgiveness decision is required within 60 days from the date of the application.

Concluding comments
As shown above, the forgiveness provisions of the CARES Act are complicated, and there are a number of unanswered questions. We expect further guidance will be available in the coming days and weeks. The House of Representatives is scheduled to go back into session on May 4, 2020 and will likely be addressing a number of the matters that may require legislation.

We will continue to provide you with updated information as it comes available.

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