The Employment Aspects of PPP Loan Forgiveness

By Lehr Middlebrooks Vreeland & Thompson, P.C.

June 25, 2020

The Paycheck Protection Program (PPP) provided key financial assistance to many small and mid-sized businesses throughout the U.S. intending to encourage those businesses to maintain employees on their payroll. Eligible businesses could receive loans from the Small Business Administration in an amount equal to up to two and a half months of their average 2019 payroll expenses. Although the loan was offered at an attractive rate with deferred payments, the most attractive aspect of a PPP loan was that amounts used for mortgage payments, rent, utilities and payroll expenses during the Covered Period would be forgiven. Much as the initial PPP loan application process was a moving target, due in large part to the need to distribute the money as quickly as possible, the forgiveness process has been an evolving paradigm of direction from the SBA and the IRS. The initial forgiveness guidance was not issued until after many PPP recipients were well into the then eight-week Covered Period for forgiveness and revised guidance was issued while this article was being drafted.

This article will highlight some aspects of the forgiveness provisions of the PPP including how employment decisions can impact the eligible amount of forgiveness. The article is not intended to address any specific factual situation and you are encouraged to contact your lending institution, accountant and/or competent legal counsel for further direction regarding a particular circumstance.

What is the maximum amount that can be forgiven?

The entire amount of a PPP loan is subject to forgiveness if the proceeds were used for Payroll Costs, a Covered Mortgage Obligation, a Covered Rent Obligation and/or a Covered Utility Payment during the Covered Period.

What is the Covered Period?

The Covered Period is the eight (8) week OR twenty-four (24) week period that commences on the date that the individual loan was funded. Initially, the Covered Period was limited to an 8-week period but the PPP Flexibility Act extended the Covered Period to 24 weeks. For loans funded prior to June 5, 2020, the loan recipient can elect either period. However, loans funded after June 5, 2020, must use a 24-week covered period. The PPP Flexibility Act extended the period so that more recipients, including recipients that had thus far been unable to completely return to full operation due to the COVID-19 health crisis, could exhaust their PPP loan proceeds in a manner that would make them eligible to be forgiven and return employees to their payrolls as they reopen. Note that there is also an Alternative Payroll Covered Period that can be elected for payroll expenses only by employers whose payroll period is biweekly or more frequent.

What are qualifying Payroll Costs?

Payroll costs are the same payroll expenditures that were used when the PPP recipient calculated the amount of loan for which the recipient was eligible. The subsequent guidance has offered some additional clarification but the following expenditures will qualify: (1) salary, wages, commissions or similar compensation; (2) cash tip or equivalent (including an employer’s ability to subsidize tipped employees who are not receiving tips); (3) paid leave other than that for which a tax credit is taken under the FFCRA; (4) severance payments; (5) group health benefits; (6) employee retirement benefits; (7) state and local payroll taxes; and (8) housing stipends. Excluded from qualifying payroll costs are compensation that is greater that $100,000 annually, IRS taxes, and compensation paid to employees outside the U.S. Further, note that the PPP Flexibility Act placed additional caps on the amount of compensation for which owners, including employee-owners of C and S corporations, are eligible for forgiveness. Although the rules are somewhat complex and vary by business structure, at a basic level, forgiveness based on compensation to owner-employees is limited to approximately 20.83% of the owner-employee’s 2019 income or $20,833.00, whichever amount is less. An employer who intends to seek forgiveness for amounts (including benefit amounts) greater than $20,833.00 paid to any individual employee, should seek guidance beforehand.

Is there a requirement that a certain percentage of PPP proceeds be spent on Payroll costs for forgiveness purposes?

At least 60% of the forgiven PPP loan proceeds must be spent on payroll costs. If an entity spends a greater percentage of the proceeds on the other qualifying expenses, the amount eligible for forgiveness will be reduced pro rata. Note that the PPP Flexibility Act decreased the required payroll costs percentage from 75% to 60% in an effort to facilitate greater forgiveness eligibility without substantially undermining the goal of sustaining payroll.

What are the employment factors that will reduce the amount of forgiveness for which a PPP loan recipient is eligible?

There are two primary employment factors that will reduce the amount of eligible forgiveness. First, the loan recipient cannot reduce the number of full-time equivalent employees (FTEE) when comparing the average number of FTEE from either February 15, 2019 – June 30, 2019 or January 1, 2020 – February 29, 2020 to December 31, 2020 (“FTEE Reduction”). Second, the employer cannot reduce the cash compensation paid to an individual employee by more than 25%. (“Compensation Reduction”). Either the FTEE Reduction or the Compensation Reduction will result in a proportional reduction of the available forgiveness amount.

What exceptions apply to the employment factors that will reduce the amount of available loan forgiveness?

In any instance where the FTEE Reduction or the Compensation Reduction is eliminated prior to December 31, 2020, the reduction(s) will not operate to reduce the amount of available forgiveness. In other words, as long as the employer has restored its number of FTEEs to the prior levels and restored an individual employee’s compensation to at least 75% of prior compensation, these reductions are inapplicable. Note that the Compensation Reduction only applies to employees who were employed during the comparison periods, not newly hired employees, and does not apply to employees with annualized pay in excess of $100,000 for any 2019 pay period. Likewise, the following categories of employees are not included as part of the FTEE analysis: (1) employees who rejected a written offer of rehire and could not be replaced; (2) employees fired for cause; (3) employees who voluntarily resigned; and (4) employees who voluntarily requested and received a reduction of hours. Finally, there is an additional “catch-all” exception for business that are able to document that they were unable to return to their prior level of business due to sanitation, social distancing or safety requirements issued by a government entity. Documentation is key to establishing that these exceptions apply. Additionally, the SBA indicated in recent guidance that an employer must report an employee who refuses to return to the employer’s state unemployment compensation office within 30 days of the employee’s refusal in order to be eligible for this exception.

How will PPP loan recipients apply for forgiveness?

Borrowers will apply for PPP loan forgiveness using Form 3508 or Form 3508EZ. Form 3508EZ is a simplified version of Form 3508, with significantly fewer schedules and worksheets. The borrower can apply for forgiveness at any point during the Covered Period after it has expended the PPP funds for which it seeks forgiveness or up to ten (10) months after the end of the Covered Period. The lending institutions will make the initial determination whether loan amounts are eligible for forgiveness and are required to inform the SBA of that determination within sixty (60) days of receiving the application for forgiveness. The SBA then has ninety (90) days to review the decision and reimburse the lending institution for the amounts forgiven. Thereafter, the lending institution is responsible for notifying the borrower what amounts were forgiven and, if the total principal amount of the PPP loan was not forgiven, when the borrower’s initial payment is due. It is important that PPP loan recipients document and retain proof of each PPP loan expenditure. Expanding the Covered Period from eight (8) to twenty-four (24) weeks makes it significantly more likely that the forgiveness process will bleed into the following calendar year, and many employers’ fiscal years. There are multiple unanswered tax implications for which guidance is likely forthcoming.

Conclusion

PPP loan forgiveness continues to be a moving target. However, there are a number of strategies that PPP recipient employers can employ to ensure maximation of the available forgiveness. Employers should work with their lender, accountant and competent counsel to map out PPP compliant strategies to ensure that forgiveness is maximized.