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PPP Loan Forgiveness Guidance Finally Issued

May 18, 2020

PPP Loan Forgiveness Guidance Finally Issued

The Paycheck Protection Program (PPP) was launched with the Coronavirus Aid, Relief and Economic Security (CARES) Act, which was enacted into law on March 27, 2020. The second round of funding for the program was put in place earlier this month. The first loans from this program were made in early April. We have previously written a number of articles addressing various provisions of the PPP, which can be accessed here.

Since the CARES Act passed, the SBA and Treasury Department have released a variety of guidance, but very little has been released about loan forgiveness, arguably the most appealing aspect of the Program.

However, on May 15, 2020, the SBA released guidance in the form of a Loan Forgiveness Application form, along with instructions and worksheets. These can be found here. This 11-page document provides much-needed guidance, and we have highlighted what we believe to be the most significant and meaningful items below.

What happens if I fail to spend at least 75% on payroll?
The SBA and Treasury released guidance in April indicating that at least 75% of the funds expended during the eight-week period (beginning with the date the loan proceeds are received) must be spent on payroll costs. Some interpreted this to mean that if less than 75% was spent on payroll costs, none of the loan would be forgiven. That interpretation also stemmed from some of the language in the promissory notes and other SBA guidance.

Language in this Loan Forgiveness Application clarifies that the failure to meet the 75% threshold does not eliminate the forgiveness entirely. Instead, it serves to reduce the amount of forgiveness.

As an example, let’s say you receive a PPP loan of $100,000. During the eight-week period, you spend $80,000, with $55,000 of that on payroll costs and $25,000 on other permissible costs. This means that only 69% ($55K divided by $80K) was spent on payroll. Because of that, the full $80K is not forgivable. Instead, only $73,333 is eligible for forgiveness ($55K divided by 75%). This means that the full $55K in payroll costs are forgivable, while only $18,333 of other costs are forgivable. Also, additional reductions to the forgivable amount may apply. More on that below.

How to identify qualifying costs within the eight-week period
The CARES Act indicates that only “costs incurred and payments made” during the eight-week period are eligible for forgiveness. Precisely what was meant by the reference to “incurred” was not clear. This guidance provides some clarity as to how the SBA will administer this provision.

Payroll costs
The guidance provides that “Payroll costs are considered incurred on the day that the employee’s pay is earned.” Employers with pay periods that are bi-weekly or more frequent can use an “alternative payroll covered period.” This alternative period essentially shifts the eight-week period to make it simpler to capture incurred and paid amounts. Here’s the example that the SBA provided:

If the Borrower received its PPP loan proceeds on Monday, April 20, and the first day of its first pay period following its PPP loan disbursement is Sunday, April 26, the first day of the Alternative Payroll Covered Period is April 26 and the last day of the Alternative Payroll Covered Period is Saturday, June 20.

In the above example, the eight-week period was shifted by a few days (for payroll cost purposes only). This should make it easier for those with these shorter payroll periods to determine what costs count. Note that if you use this alternative period, you also must use it when determining your full-time equivalent (FTE) headcount. More on that below. It’s also unclear how much payroll that is being paid in arrears can be paid and counted within the eight-week period. For example, if you suspended or reduced pay prior to receiving the loan, it appears that any catch-up compensation paid within the eight-week period would count towards the forgiveness.

In addition, regardless of the length of your regular payroll period, payroll costs incurred during the eight-week period but not paid until after the end of the eight-week period are still eligible for forgiveness, so long as they are paid by the next payroll.

In the end, a full eight weeks’ worth of payroll will be included so long as those amounts are paid on the regular payroll cycle.

Other qualifying costs
Other costs that the PPP loan funds can be expended are 1) interest incurred on debt existing before February 15, 2020; 2) rents or leases that stem from an agreement in effect prior to February 15, 2020; and 3) utilities on services that were in place before February 15, 2020. Note that mortgage interest and rents can be for real estate or personal property such as vehicles or equipment.

According to the guidance, these costs must be either 1) paid during the eight-week period or 2) incurred during the eight-week period and paid on or before the next regular billing date, even if that payment is after the end of the eight-week period. Remember, the sum of these non-payroll costs will be limited to a maximum of 25% of the total amount eligible for forgiveness.

How are FTEs determined?
The CARES Act provides that once the eligible eight-week costs are determined, the forgiveness will be reduced to the extent that the average FTE headcount during the eight-week period is lower than it was during a base period. That base period is generally either February 15-June 30, 2019, or January 1-February 29, 2020; employers will want to pick the lower of these two dates. The base period may be different for seasonal employers. However, the Act was silent on how to define “full-time.”

The application instructions indicate that a full-time employee is one that works 40 hours or more. To calculate FTEs, you’ll enter the average number of hours paid by each employee per week, divide that by 40, and round the total to the nearest tenth; the maximum for each employee is 1.0. If you want to make it simpler, you’re allowed to use 1.0 for employees who work 40 hours weekly and 0.5 for employees who work less than 40 hours weekly.

Let’s look at an example. You have fifteen employees during the eight-week period. For simplicity, we’ll assume that throughout the eight-week period all employees work a constant number of hours. Ten of the employees work 40 hours or more each week, while the other five work fifteen hours each week. Each part-time employee counts as .4 FTE (fifteen hours divided by 40 hours). Five part-time employees at .4 each equates to 2.0 FTEs. Added to the ten employees that work 40 hours or more, you arrive at a total of twelve FTEs. Note that using the simplified calculation that the SBA allows, each part-time employee would count for .5 FTEs, resulting in 12.5 total FTEs, a slightly better.

FTE safe harbor
For employers whose FTE headcount was reduced between February 15, 2020, and April 26, 2020, the CARES Act includes a safe harbor allowing certain hiring completed after the end of the eight-week period and through June 30 to cancel the FTE headcount reduction. Said another way, regardless of when your eight-week period ends, if by June 30 you hire enough FTEs to eliminate the reduction that occurred between February 15 and April 26, those reductions will be ignored and the forgiveness will not be for a loss in FTEs.

While many, and prior guidance suggested, that hiring back any employees by June 30 would help, the SBA forgiveness application and instructions make it clear that this safe harbor only applies if the reduction in FTEs is fully eliminated. In other words, unless the reductions occurring between these dates are fully replaced by June 30, then you’re subject to the normal FTE headcount reduction discussed in the previous section.

Here’s an example. You obtain a PPP loan on April 14, and the end of your eight-week period is June 8. You employ twenty FTEs during all of 2019 and prior to February 15, 2020. You make the decision to let ten of your FTEs go in March, resulting in ten remaining FTEs, and you have that same number through June 8. This is 50% of your previous FTE headcount. On June 29 you hire ten FTEs, restoring your FTE headcount to twenty, just as it was before February 15. In this example, you meet the safe harbor, which means your eligible forgiveness amount will not be reduced due to the lower headcount during the eight-week period. However, if you had only hired eight FTEs by June 30, you would fall just short of meeting the safe harbor. Those additional eight hires made after June 8 would not count. As a result, only 50% of the amount eligible for forgiveness would actually be forgiven.

Other exceptions to the FTE reduction
If a company makes a good-faith, written offer to rehire an employee during the Covered Period or the Alternative Payroll Covered Period (at the same pay rate and for the same number of hours) and the employee rejects the offer, that employee can nevertheless be included in the FTE headcount. The employee’s rejection of the offer should be documented.

In addition, reductions in the number of FTEs that stem from the following reasons will not reduce the loan forgiveness, so long as these employees have not been replaced: 1) terminations for cause, 2) voluntary resignations, or 3) requests to work reduced hours.

Compensation
In addition to loan forgiveness being reduced due to a reduced number of FTEs, it can be further reduced if an employee’s compensation during the eight-week period is lowered by more than 25%. To determine this, the language in the Act requires a comparison of each employee’s compensation during the eight-week period with that of the 1st quarter of 2020 (January 1 through March 31). Some interpreted this provision to mean that the dollars spent on an employee during the eight weeks must be compared to the 3 months of compensation spent during the 1st quarter; that would nearly always result in a deemed reduction by more than 25%.

However, this loan forgiveness application clarifies that the calculation is based on the annual compensation level (salary or hourly wage) paid during these periods, not the actual dollar amounts paid. This makes sense and is what many understood the intent of the CARES Act to be.

Similar to the FTE safe harbor, employers can restore compensation levels by June 30 and avoid this additional reduction to the loan forgiveness.

Remember that only amounts incurred and paid (as discussed above) during the eight-week period can be forgiven. So, if employees are hired or compensation is restored late in the eight-week period, you won’t spend as much of the PPP loan funds, and this could directly impact the amount that can be forgiven.

Could the eight-week period be extended?
Many groups have expressed to Congress the need to extend or delay the start of the eight-week period that is used to determine the amount of loan forgiveness. Many companies could benefit from such a change, particularly those in the food, lodging, retail, and tourism industries. Extending or delaying the eight-week period would move the period considered for spending the loan funds outside the immediate impact of the stay at home orders and related restrictions directly impacting them.

It’s uncertain if such relief will be granted, but last week a bill was introduced in the House of Representatives that included a provision to make such an extension. The Health and Economic

Recovery Omnibus Emergency Solutions (HEROES) Act proposes to extend the current eight-week period to the end of 2020. While it’s been reported that many provisions of the extensive bill will not have adequate support to pass, we have also heard from members of the Senate indicating that there is interest in extending the current eight-week period.

As there appears to be some interest in extending the current eight-week period, businesses may want to consider waiting as long as possible before applying for loan forgiveness. Keep in mind that the first loan payment is not due until six months after the loan is received, which will be well after the eight-week period has ended and you’re eligible to apply for loan forgiveness.

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