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SBA Clarifies Loan Forgiveness Limits for Owner Compensation; Releases New EZ Loan Forgiveness Application and Other PPP-Related Guidance
(Parker Tax Publishing July 2020)
The Small Business Administration (SBA) recently issued four more interim final rules relating to the Paycheck Protection Program (PPP) that (1) clarify the amount of compensation that self-employed individuals and owner-employees are eligible to have forgiven; (2) modify the existing rules to conform to the PPP Flexibility Act of 2020; (3) update PPP eligibility rules regarding felony convictions; and (4) provide new guidance which addresses payroll costs that may be included on a PPP loan application submitted by fishing boat owners. The SBA also updated the FAQs relating to the PPP, revised its PPP loan forgiveness application, revised its PPP borrower application, and issued a new EZ loan forgiveness application in an effort to streamline the loan forgiveness process. SBA-2020-0037 (6/19/20); SBA-2020-0038 (6/26/20); SBA-2020-0039 (6/26/20); SBA-2020-0040 (6/30/20).
Updates to SBA Interim Final Rules
On June 19 and June 26, the U.S. Small Business Administration (SBA) issued two more PPP-related final interim rules (SBA-2020-0037 and SBA-2020-0038, respectively) which revise earlier PPP-related rules in order to be consistent with changes made by the PPP Flexibility Act of 2020 (Pub. L. 116-142, June 5, 2020). Among other changes, the PPP Flexibility Act (1) changed the length of the covered period, which relates to the period during which PPP loans may be forgiven and which was extended from eight weeks to 24 weeks, (2) amended the requirements regarding forgiveness of PPP loans to reduce, from 75 percent to 60 percent, the amount of PPP loan proceeds that must be used for payroll costs for the full amount of the PPP loan to be eligible for forgiveness; and (3) provides that if the borrower does not apply for forgiveness of a loan within 10 months after the last day of the covered period, the PPP loan is no longer deferred and the borrower must begin paying principal and interest.
In SBA-2020-0037, the SBA sets out the amount of a loan that may be forgiven and provides that the actual amount of loan forgiveness will depend, in part, on the total amount spent over the 24-week period, beginning on the date the borrower's PPP loan is disbursed (i.e., the covered period), on:
(1) payroll costs including salary, wages, and tips, up to $100,000 of annualized pay per employee (for 24 weeks, a maximum of $46,154 per individual, or for eight weeks, a maximum of $15,385 per individual), as well as covered benefits for employees (but not owners), including health care expenses, retirement contributions, and state taxes imposed on employee payroll paid by the employer (such as unemployment insurance premiums);
(2) owner compensation replacement, calculated based on 2019 net profit, with forgiveness of such amounts limited to eight weeks' worth (8/52) of 2019 net profit (up to $15,385) for an eight-week covered period or 2.5 months' worth (2.5/12) of 2019 net profit (up to $20,833) for a 24-week covered period, but excluding any qualified sick leave equivalent amount for which a credit is claimed under Section 7002 of the Families First Coronavirus Response Act (FFCRA) (Pub. L. 116-127) or qualified family leave equivalent amount for which a credit is claimed under Section 7004 of FFCRA;
(3) payments of interest on mortgage obligations on real or personal property incurred before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business mortgage payments);
(4) rent payments on lease agreements in force before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business rent payments); and
(5) utility payments under service agreements dated before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business utility payments).
The SBA stated that it has determined that it is appropriate to limit the forgiveness of owner compensation replacement for individuals with self-employment income who file a Schedule C or F to either eight weeks' worth (8/52) of 2019 net profit (up to $15,385) for an eight-week covered period or 2.5 months' worth (2.5/12) of 2019 net profit (up to $20,833) for a 24-week covered period per owner in total across all businesses.
Observation: According to the SBA, this approach is consistent with the structure of the CARES Act and its overarching focus on keeping workers paid, and will prevent windfalls that Congress did not intend. Specifically, the SBA noted, Congress determined that the maximum loan amount is generally based on 2.5 months of the borrower's average total monthly payroll costs during the one-year period preceding the loan. Thus, a borrower with one other employee would receive a maximum loan amount equal to five months of payroll (2.5 months of payroll for the owner plus 2.5 months of payroll for the employee). If the owner laid off the employee and availed itself of the safe harbor in the PPP Flexibility Act from reductions in loan forgiveness for a borrower that is unable to return to the same level of business activity the business was operating at before February 15, 2020, the owner could treat the entire amount of the PPP loan as payroll, with the entire loan being forgiven. This would not only result in a windfall for the owner, by providing the owner with five months of payroll instead of 2.5 months, but also defeat the purpose of the CARES Act of protecting the paycheck of the employee. The SBA noted that, for borrowers with no employees, this limitation will have no effect, because the maximum loan amount for such borrowers already includes only 2.5 months of their payroll.
In SBA-2020-0038, additional text is added to the interim final rules to follow a change made by the PPP Flexibility Act which provides that if the borrower does not apply for forgiveness of a loan within 10 months after the last day of the covered period, the PPP loan is no longer deferred and the borrower must begin paying principal and interest. SBA-2020-0038 also revises the interim final rules to comply with the PPP Flexibility Act's extension of the length of the covered period while also allowing borrowers that received PPP loans before June 5, 2020 to elect to use the original eight-week covered period.
Example: A borrower that received a PPP loan before June 5, 2020, and elects to use an eight-week covered period, has a bi-weekly payroll schedule (with payments made every other week). The borrower's eight-week covered period begins on June 1 and ends on July 26. The first day of the borrower's first payroll cycle that starts in the covered period is June 7. The borrower may elect an alternative payroll covered period for payroll cost purposes that starts on June 7 and ends 55 days later (for a total of 56 days), on August 1. Payroll costs paid during this alternative payroll covered period are eligible for forgiveness. In addition, payroll costs incurred during this alternative payroll covered period are eligible for forgiveness if they are paid on or before the first regular payroll date occurring after August 1. Payroll costs that were both paid and incurred during the covered period (or alternative payroll covered period) may only be counted once.
Changes to PPP Eligibility Rules for Felony Convictions
Also on June 26, the SBA issued SBA-2020-0039. In that guidance, the SBA further revised the PPP eligibility requirements relating to felony convictions of PPP applicants or owners of the applicant. The SBA determined that two additional modifications to the first interim final rule are appropriate to ensure a consistent approach to applicants with criminal histories. First, the original rules provided that an applicant is ineligible for a PPP loan if an owner of 20 percent or more of the equity of the applicant is presently subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction. The SBA determined that this restriction should be limited to pending criminal charges for felony offenses.
Second, the original rules provided that an applicant was ineligible for a PPP loan if an owner of 20 percent or more of the equity of the applicant is on probation or on parole. The SBA has determined that this restriction should be limited to individuals whose probation or parole began within specified time periods -- i.e., within the last five years for any felony involving fraud, bribery, embezzlement, or a false statement in a loan application or an application for federal financial assistance, and within the last one year for other felonies. This amendment does not affect the rule regarding applicants that are presently suspended, debarred, or proposed for debarment, which remains effective.
Observation: As a result of these changes, the SBA revised the PPP Borrower Application Form, effective June 24, 2020.
PPP and Fishing Boat Owners
In SBA-2020-0040, the SBA addresses payroll costs that may be included on a PPP loan application submitted by certain boat owners or operators that are engaged in catching fish or other forms of aquatic animal life (fishing boat owners) and that have hired one or more crewmembers who are regarded as independent contractors or otherwise self-employed for certain federal tax purposes under Code Sec. 3121(b)(20). A fishing boat owner must report compensation paid to such a crewmember on Box 5 of IRS Form 1099-MISC. The SBA's First Interim Final Rule, posted on April 2, 2020, provided that because independent contractors have the ability to apply for a PPP loan on their own, they do not count for purposes of another applicant's PPP loan calculation. The SBA noted that, because crewmembers described in Code Sec. 3121(b)(20) are treated as independent contractors or otherwise self-employed for certain federal tax purposes, fishing boat owners have faced uncertainty about whether to report payments to such crewmembers as a payroll cost on their PPP loan applications.
On April 14, 2020, SBA posted an interim final rule explaining that the self-employment income of the general active partners of a partnership could be reported as a payroll cost, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership. The SBA said that it has determined that the relationship of a fishing boat owner and a crewmember described in Code Sec. 3121(b)(20) is analogous to a joint venture or partnership. For example, the fishing boat owner and crewmembers each contribute labor or resources to a common commercial enterprise, and the owner and crewmembers share in the enterprise's profits. In order to harmonize SBA's interim final rule regarding partnerships with SBA's interim final rule described above regarding independent contractors, the SBA has determined that in the event of a conflict (i.e., a case where one or more partners in a partnership are treated as independent contractors for tax purposes), the rules regarding partnerships will govern. In SBA-2020-0040, the SBA (1) provides that a fishing boat owner may include compensation reported on Box 5 of Form 1099-MISC and paid to a crewmember described in Code Sec. 3121(b)(20) as a payroll cost in its PPP loan application, and (2) addresses a fishing boat owner's eligibility to obtain loan forgiveness of payroll costs paid to a crewmember who has obtained his or her own PPP loan.
Expanded FAQs
The SBA has added a question to it PPP Frequently Asked Questions (PPP FAQs, June 25, 2020). Q&A 49 deals with the maturity date of a PPP loan. The FAQ provides that, if a PPP loan received an SBA loan number on or after June 5, 2020, the loan has a five-year maturity. If a PPP loan received an SBA loan number before June 5, 2020, the loan has a two-year maturity, unless the borrower and lender mutually agree to extend the term of the loan to five years.
SBA Revises Loan Forgiveness Application and Issues New EZ Form
The SBA also, in consultation with the Department of the Treasury, posted a revised PPP loan forgiveness application (Revised PPP Loan Application June 16 2020; Revised SBA Form 3508 PPP Forgiveness Application Instructions). The revised application, which is only five pages long including the last page, which requests optional demographic information, implements changes made by the PPP Flexibility Act. In addition to revising the full forgiveness application, the SBA also published a new EZ version of the forgiveness application, Form 3508EZ, which is only three pages long including the last page, which also requests optional demographic information (PPP Loan Forgiveness Form 3508EZ; Form 3508EZ Instructions). Form 3508EZ applies only to borrowers that:
(1) are self-employed and have no employees; or
(2) did not reduce the salaries or wages of their employees by more than 25 percent, and did not reduce the number or hours of their employees; or
(3) experienced reductions in business activity as a result of health directives related to COVID-19, and did not reduce the salaries or wages of their employees by more than 25 percent.
The EZ application requires fewer calculations and less documentation for eligible borrowers.
Both loan forgiveness applications give borrowers the option of using the original eight-week covered period (if their loan was made before June 5, 2020) or the extended 24-week covered period. These changes should result in a more efficient process and make it easier for businesses to realize full forgiveness of their PPP loan.
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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