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A Tax Practitioner's Guide to the Paycheck Protection Program (PPP). (Client Letter Included)
(Parker Tax Publishing April 8, 2020)
In the face of unprecedented economic disruptions due to the Coronavirus (COVID-19) outbreak, a Paycheck Protection Program was authorized as part of the CARES Act that was signed into law on March 27, 2020. This new loan program authorizes the Small Business Administration to guarantee $349 billion in new loans to eligible businesses and nonprofits and, if certain criteria are met, the loan may qualify for tax-free loan forgiveness. Because the loans are available until the later of June 30 or until the money runs out, time is of the essence in applying for such loans and many business owners will need their tax advisor's help in navigating the requirements that must be met to obtain such loans. The following is in-depth look at the program, its benefits, the criteria that must be met to obtain a loan, and the rules for loan forgiveness.
Practice Aid: For a CLIENT LETTER explaining the Paycheck Protection Program, CLICK HERE .
Additional Resources: Those wishing to take a deeper dive may want to download the following:
Pub. L. 116-136, Sec. 1102 (creates the PPP and authorizes loans under the program)
Pub. L. 116-136, Sec. 1106 (establishes rules for loan forgiveness)
SBA-2020-0015 (SBA's interim final rules for loans under the program)
SBA Form 2483 (PPP Borrower Application Form.)
I. Background
The CARES Act (Pub. L. 116-136) includes a loan program titled the "Paycheck Protection Program" (PPP). The program authorizes the Small Business Administration (SBA) to guarantee $349 billion in new loans to eligible businesses and nonprofits affected by coronavirus/COVID-19. Such loans may also qualify for tax-free loan forgiveness. Maximum loan amounts, subject to a $10 million limit, are set at 2.5 times the borrower's average monthly payroll costs. Loan proceeds can be used for payroll costs, utility payments, rent, and interest on certain mortgages.
In addition to the potential for tax-free forgiveness, PPP loans offer the following benefits:
(1) Interest rates set at 1 percent for all borrowers.
(2) No personal guarantee is required.
(3) No collateral is required.
(4) Loans are nonrecourse with respect to shareholders, members, and partners as long as proceeds are used in accordance with the loan terms.
(5) No fees for borrowers.
(6) All loan payments are deferred for six months (however, interest still accrues).
(7) To the extent balances are not forgiven, loans mature in two years.
(8) Fully guaranteed by the SBA.
(9) Not contingent on the borrower's creditworthiness (but delinquency on other open SBA loans and past defaults can be disqualifying).
Observation: The main downside of the loans is that they are heavily predicated on borrowers maintaining the employee headcounts that they had going into the COVID-19 crisis, and keeping any reductions in wages and salaries within specified limits - actions that may not be feasible for some businesses in a highly uncertain business environment.
The SBA issued interim final rules in SBA-2020-0015, which outline the key provisions of the SBA's implementation of business loans under the PPP.
II. How to Apply for a Loan
In order to receive a PPP loan, an authorized representative of the borrower needs to complete SBA Form 2483, Paycheck Protection Program Borrower Application Form, and submit it to the borrower's SBA participating lender. The SBA's interim final regulations indicate that an authorized representative is an individual legally authorized to represent the borrower. The SBA has three lending programs: 7(a), CDC/504, and Microloan. Each program has its own lending practices and eligibility requirements for lenders. The PPP loan falls under the 7(a) loan program.
Practice Tip: The AICPA issued a statement clarifying that the CARES Act prohibits CPAs and accounting firms from collecting fees from small business clients they help apply for PPP loans. The restrictions apply to CPAs and firms that act as official application agents as defined in the CARES Act. CPAs who serve as agents should receive compensation for their work, but the Treasury Department has designated that lenders pay agents out of their fee. In its statement, the AICPA said that its understanding is that the limitation on fees applies to fees for assistance in the preparation of a loan application for a loan available under the PPP. If an accounting firm charges fees for providing a small business with advice on deciding which loan program and tax relief program would be best for their business, the statement says that the AICPA thinks it is "reasonable that those fees would fall outside this provision of the CARES Act."
Under the 7(a) loan program, banks, savings and loans, credit unions, and other specialized lenders participate with the SBA on a deferred basis to provide small business loans that are structured under 7(a) guidelines. If a borrower defaults on an SBA-guaranteed loan, the lender may ask the SBA to purchase the guaranteed portion. To participate in the 7(a) loan program, a lender must meet the following requirements:
(1) Have a continuing ability to evaluate, process, close, disburse, service, and liquidate small business loans
(2) Be open to the public to issue loans (and not be a financing subsidiary, engaged primarily in financing the operations of an affiliate)
(3) Have continuing good character and reputation, and otherwise meet and maintain certain ethical requirements
(4) Be supervised and examined by a state or federal regulatory authority, satisfactory to the SBA
Applicants must apply for the loans by June 30, 2020, because that is when the PPP expires. However, loans are available only as long as the $349 billion lasts. The loans are geared towards borrowers that have an existing relationship with an SBA participating lender.
III. Key Definitions
The following definitions are integral to applying the various provisions of the CARE Act's Paycheck Protection Program (PPP), which is codified in 15 U.S.C. 636(a)(36).
Covered Period. The "covered period" is the period beginning on February 15, 2020, and ending on June 30, 2020.
Caution: The term "covered period" has different definitions for purposes of applying for a PPP loan and for purposes of forgiving a PPP loan.
Covered Loan. A "covered loan" is a loan meeting the requirements of the PPP that is made during the covered period. Covered loans are also referred to a "PPP loans."
Eligible Recipient. An "eligible recipient" means an individual or entity that is eligible to receive a covered loan.
Payroll Costs. The term "payroll costs," refers to outlays for compensation and benefits.
IV. Eligible Recipients of PPP Loans
PPP loans may only be made to "eligible recipients."
Subject to limits based on number of employees (discussed below), eligible recipients may include:
(1) any business;
(2) nonprofit organizations exempt from tax under Code Sec. 501(c)(3);
(3) veterans organizations described in Code Sec. 501(c)(19) that are exempt from tax under Code Sec. 501(a); and
(4) tribal business concerns.
The following categories of individuals, businesses, and organizations are specifically listed as INELIGIBLE for PPP loans by the SBA's interim final rules:
(1) household employers (i.e., individuals who employ household employees such as nannies or housekeepers);
(2) those engaged in any activity that is illegal under federal, state, or local law;
(3) a business with a 20-percent-or-more owner who is incarcerated, on probation, on parole; presently subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or has been convicted of a felony within the last five years; or
(4) any individual, organization, business, or business with any owner who/that has ever obtained a direct or guaranteed loan from SBA or any other federal agency that is currently delinquent or has defaulted within the last seven years and caused a loss to the government.
Observation: Because distribution of marijuana remains illegal under federal law, it would appear that marijuana dispensaries and medical marijuana distributors that are legal businesses under state law are ineligible for PPP loans.
Sole proprietors, independent contractors, and "eligible self-employed individuals" may be eligible to receive PPP loans, but are required to submit documentation to establish themselves as eligible, including payroll processor records, payroll tax filings, Forms 1099 - MISC, or income and expenses from the sole proprietorship.
For borrowers that do not have any such documentation, the borrower must provide other supporting documentation, such as bank records, sufficient to demonstrate the qualifying payroll amount. The term "eligible self-employed individual" has the same meaning as it has for Families First Coronavirus Response Act (Pub. L. 116 - 127): an individual who (1) regularly carries on any trade or business within the meaning of Code Sec. 1402, and (2) would be entitled to receive paid leave during the tax year pursuant to the Emergency Paid Sick Leave Act if the individual were an employee of an employer (other than himself or herself).
Eligible recipients must have been in operation on February 15, 2020, and either paid salaries/wages to employees (with respect to which payroll taxes were paid) or paid independent contractors, as reported on a Form 1099-MISC.
500 Employee Limit (with Exceptions). Eligible recipients must either have 500 or fewer employees whose principal place of residence is in the United States, or be a business that operates in a certain industry and meets the applicable SBA employee-based size standards for that industry.
In determining the how many people a business concern employs, prospective borrowers will need to consider the SBA's affiliation rules, which factor in common ownership and control of related concerns. These complex rules, which are beyond the scope of this chapter, are waived for certain businesses for purposes of the paycheck protection program.
V. "Payroll Costs" Defined
As a key component in determining both the maximum PPP loan amount and the amount that can be forgiven, "payroll costs" are central to the loan program. The term is defined to mean the sum of:
(1) payments of any compensation with respect to employees; and
(2) payments of any compensation to or income of a sole proprietor or independent contractor 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.
Compensation with respect to employees includes:
(1) salary, wage, commission, or similar compensation;
(2) payment of cash tip or equivalent;
(3) payment for vacation, parental, family, medical, or sick leave;
(4) allowance for dismissal or separation;
(5) payment required for the provisions of group health care benefits, including insurance premiums;
(6) payment of any retirement benefit; and
(7) payment of state or local tax assessed on the compensation of employees.
Compensation with respect to employees excludes:
(1) the compensation of an individual employee in excess of an annual salary of $100,000, as prorated for the covered period;
(2) taxes imposed or withheld under Internal Revenue Code chapters 21, 22, or 24 (employment taxes) during the covered period;
(3) any compensation of an employee whose principal place of residence is outside of the United States;
(4) qualified sick leave wages for which a credit is allowed under the Family First Act (i.e., payroll tax credit for required paid sick leave);
(5) qualified family leave wages for which a credit is allowed under the Family First Act (i.e., payroll credit for required paid family leave); and
(6) payments to independent contractors.
VI. Maximum PPP Loan Amount
The formula used to determine a loan applicant's maximum loan amount depends on whether or not the applicant's business is seasonal and whether the applicant was in business during a specified reference period (discussed below). In all scenarios, the maximum loan amount is determined by the applicant's payroll costs (as discussed above), but cannot be more than $10 million.
General Rule. Subject to a $10 million limit, the maximum amount of a covered loan under the CARES Act's Paycheck Protection Program is determined by multiplying:
(1) the average total monthly payments by the applicant for payroll costs incurred during the one-year period before the date on which the loan is made; by
(2) 2.5
Special Rule for Seasonal Employers. In the case of an applicant that is seasonal employer, as determined by the SBA Administrator, the maximum amount of a covered loan is determined by multiplying:
(1) the average total monthly payments for payroll for the 12-week period beginning February 15, 2019, or at the election of the eligible recipient, March 1, 2019, and ending June 30, 2019; by
(2) 2.5
Special Rule for Applicants Who Were Not in Business During 2019 Reference Period. If requested by an otherwise eligible recipient that was not in business during the period beginning on February 15, 2019, and ending on June 30, 2019, the maximum amount of a covered loan is determined by multiplying:
(1) the average total monthly payments by the applicant for payroll costs incurred during the period beginning on January 1, 2020, and ending on February 29, 2020; by
(2) 2.5
Special Rule for Applicants with Outstanding Economic Injury Disaster Loans. Special rules apply to applicants with outstanding Economic Injury Disaster Loans (EIDLs) made under the SBA's Disaster Loan Program on or after January 31, 2020. EIDLs may be refinanced as qualified loans under the PPP, potentially increasing the applicant's maximum loan amount.
The interim final rules recommend the following methodology for determining the maximum loan amount:
(1) Step 1: Aggregate payroll costs from the last 12 months for employees whose principal place of residence is the United States.
(2) Step 2: Subtract any compensation paid to an employee in excess of an annual salary of $100,000 and/or any amounts paid to an independent contractor or sole proprietor in excess of $100,000 per year.
(3) Step 3: Calculate average monthly payroll costs (divide the amount from Step 2 by 12).
(4) Step 4: Multiply the average monthly payroll costs from Step 3 by 2.5.
(5) Step 5: Add the outstanding amount of an 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).
The following examples illustrate the methodology:
Example 1: Scenario: No employees make more than $100,000. Step 1: Annual payroll = $120,000. Step 2: Not required. Step 3: Average monthly payroll = $10,000 ($120,000 / 12). Step 4: Multiply by 2.5 = $25,000. Step 5: Not required. Result: The maximum loan amount is $25,000.
Example 2: Scenario: Some employees make more than $100,000. Step 1: Annual payroll = $1,500,000, including Employee 1 who made $300,000 and Employee 2 who made $200,000 (no other employees made more than $100,000). Step 2: Subtract $200,000 of excess compensation for Employee 1 ($300,000 - $100,000 limit) and $100,000 of excess compensation for Employee 2 ($200,000 - $100,000 limit) to arrive at an adjusted annual payroll of $1,200,000 ($1,500,000 - $200,000 - $100,000). Step 3: Average monthly payroll = $100,000 ($1,200,000 / 12). Step 4: Multiply by 2.5 = $250,000. Step 5: Not required. Result: The maximum loan amount is $250,000.
Example 3: Scenario: No employees make more than $100,000, outstanding EIDL loan of $10,000. Step 1: Annual payroll = $120,000. Step 2: Not required. Step 3: Average monthly payroll = $10,000 ($120,000 / 12). Step 4: Multiply by 2.5 = $25,000. Step 5: Add EIDL loan of $10,000 = $35,000. Result: The maximum loan amount is $35,000.
VII. Allowable Uses of PPP Loans and Required Applicant Certifications
PPP loans may be used for:
(1) payroll costs;
(2) costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums;
(3) utility payments;
(4) rent payments;
(5) mortgage interest payments (but not mortgage prepayments or principal payments);
(6) interest payments on any other debt obligations that were incurred before February 15, 2020; and/or
(7) refinancing an SBA EIDL made between January 31, 2020 and April 3, 2020.
The interim final rules issued by the SBA require that 75 percent of the proceeds of covered loans must be used for payroll costs.
Observation: The 75-percent-for-payroll-costs requirement in the interim final rules does not appear in the CARES Act. Some commentators have questioned whether the SBA or the Treasury Secretary have the authority to add such a requirement in administrative guidance. Barring a change, it's difficult to see cautious loan applicants/recipients having any practical choice but to follow the guidance and adhere to the 75 percent rule.
Caution: The SBA's interim final rules include the following warning with respect to misuse of funds: "If you use PPP funds for unauthorized purposes, SBA will direct you to repay those amounts. If you knowingly use the funds for unauthorized purposes, you will be subject to additional liability such as charges for fraud. If one of your shareholders, members, or partners uses PPP funds for unauthorized purposes, SBA will have recourse against the shareholder, member, or partner for the unauthorized use."
An eligible recipient applying for a covered loan is required to make numerous good faith certifications, including that:
(1) Current economic uncertainty makes the loan request necessary to support the ongoing operations of the applicant.
(2) The funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments; and the applicant understands that if the funds are knowingly used for unauthorized purposes, the federal government may hold him or her legally liable and the applicant could be charged with fraud.
(3) During the period beginning on February 15, 2020, and ending on December 31, 2020, the applicant has not and will not receive another loan under the PPP.
(4) The information provided in the application and the information provided in all supporting documents and forms is true and accurate in all material respects, and that the applicant understands that knowingly making a false statement to obtain a guaranteed loan from SBA is punishable under the law, including with fines of up to $1 million and imprisonment of up to 30 years (SBA-2020-0015, page 18).
VIII. Forgiveness of PPP Loans
PPP loans can be forgiven up to an amount equal to the sum of certain costs incurred and payments made during the eight-week period beginning on the loan origination date ("covered period").
Observation: The term "covered period" has a different meaning in the context of PPP loan eligibility than it does for purposes of PPP loan forgiveness. The former refers to the period from February 15, 2020, through June 30, 2020, during which eligible recipients may receive PPP loans. The latter refers to the eight-week period beginning on the date the loan is funded.
Tentative Forgiveness Amount. Subject to possible reductions based on a reduction in employee count or salaries and wages (discussed below), a tentative forgiveness amount, not to exceed the original principal amount of the loan, can be determined by combining the following costs incurred and payments made during the covered period:
(1) Payroll costs (which must account for at least 75 percent of the use of the PPP loan proceeds);
(2) Covered utility payments;
(3) Covered rent obligations; and
(4) Interest payments on any covered mortgage obligation (excluding any payment or prepayment of principal).
Definitions. "Payroll costs" are defined above under the heading "Payroll Costs Defined". A "covered utility payment" means the payment for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020. A "covered rent obligation" means rent obligated under a lease in force before February 15, 2020. A "covered mortgage obligation" means any indebtedness or debt instrument incurred in the ordinary course of business that (1) is a liability of the borrower, (2) is a mortgage on real or personal property, and (3) was incurred before February 15, 2020.
Reduction Based on a Reduction in Employee Count
General Rule. The CARES Act provides that the amount of loan forgiveness must be reduced, but not increased, by multiplying the tentative forgiveness amount (discussed above) by the quotient obtained by dividing:
(1) the average number of full-time equivalent employees per month employed by the borrower during the covered period; by
(2) at the election of the borrower: (i) the average number of full-time equivalent employees per month employed by the borrower during the period beginning on February 15, 2019, and ending on June 30, 2019; or (ii) the average number of full-time equivalent employees per month employed by the borrower during the period beginning on January 1, 2020, and ending on February 29, 2020.
Special Rule for Seasonal Employers. In the case of a borrower that is seasonal employer, as determined by the Administrator, the borrower is required to use for the denominator (i.e., for (2), above), the average number of full-time equivalent employees per month employed by the borrower during the period beginning on February 15, 2019, and ending on June 30, 2019.
Calculation of Average Number of Employees. The average number of full-time equivalent employees is determined by calculating the average number of full-time equivalent employees for each pay period falling within a month.
Exemption for Re-Hires. The reduction in loan forgiveness does not apply to the extent that - (1) the reduction in the number of full-time equivalent employees occurred between February 15, 2020, and April 26, 2020, and (2) the employer eliminates the reduction no later than June 30, 2020.
Observation: The exemption for re-hires appears to be an all-or-nothing proposition, as there is no provision in the statute for restoring some, but not all, of the lost headcount. The exemption does not apply to reductions in employee headcount occurring after April 26, 2020, even if the reductions are reversed by June 30, 2020.
Reduction Relating to Salary and Wages
General Rule. The amount of loan forgiveness must be reduced by the amount of any reduction in total salary or wages of any employee (as defined below) during the covered period that is in excess of 25 percent of the total salary or wages of the employee during the most recent full quarter during which the employee was employed before the covered period.
"Employee" Defined. For purposes of applying the above rule, an "employee" is defined as any employee who did not receive, during any single pay period during 2019, wages or salary at an annualized rate of pay in an amount more than $100,000.
Exemption for Restoration of Salaries and Wages. The reduction in loan forgiveness does not apply to the extent that - (1) the reduction in salary or wages occurred between February 15, 2020, and April 26, 2020, and (2) the employer eliminates the reduction no later than June 30, 2020.
Observation: It appears that the exemption for reversing cuts in salaries and wages applies only if the employer eliminates the cuts for all affected employees by June 30, 2020. The language is a bit vaguer in this regard than the language for the exemption for re-hires (discussed above), but it seems unlikely Congress intended one thing for the exemption for re-hires, and another for the exemption for restoring salaries and wages. Also, because the statute requires employers to eliminate pay cuts to qualify for the exemption, simply raising salaries and wages back to a level where the cuts are within the 25 percent permitted by the CARES Act will likely not allow the employer to qualify for the exemption.
Gray Area: It's unclear whether the permitted reduction of salaries and wages of up to 25 percent must be applied on an annualized basis, or whether employers are permitted to reduce salaries and wages during the 8-week "covered period" by a flat amount equal to 25 percent of salaries and wages during the 13-week "most recent full quarter." In the former scenario (annualizing), the salary of an employee who makes $52,000/year could be reduced to $39,000/year (so, from $1,000/week to $750/week = a $2,000 reduction for the covered period ($250 weekly reduction x 8 weeks)). In the latter scenario, the salary of the same employee could be reduced to $593.75/week during the covered period ($52,000 salary = $13,000 salary for the "most recent full quarter" x 25% = $3,250 / 8 (weeks in covered period) = $406.25 reduction in weekly salary ($1,000/week - $406.25 = $593.75).
Applying for Loan Forgiveness
A borrower seeking loan forgiveness under the PPP is required to submit an application to the lender that is servicing the PPP loan. The application must include:
(1) Documentation verifying the number of full-time equivalent employees on payroll and pay rates, as required to determine whether a reduction in the amount forgiven due to a reduction in employee count or salaries and wages (see ¶170,955) is required. Such documentation includes (a) payroll tax filings reported to the IRS, and (b) State income, payroll, and unemployment insurance filings.
(2) Documentation, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments.
(3) A certification from a representative of the eligible recipient authorized to make such certifications that (a) the documentation presented is true and correct, and (b) the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, or make covered utility payments.
(4) Any other documentation the SBA Administrator determines necessary.
Decisions on applications for loan forgiveness are made by the lender that is servicing the PPP loan, no later than 60 days after the date on which a lender receives an application for loan forgiveness.
Tax Treatment of Forgiven Amounts
The CARES Act provides that amounts that are forgiven are considered canceled indebtedness any amount which would ordinarily be includible in gross income of the borrower are excluded from gross income.
Also see: In-Depth: A Tax Practitioner's Guide to the CARES Act.
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
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