The Paycheck Protection Program (“PPP”) provided (some) small businesses with loans to help them stay afloat during this unprecedented economic crisis. One of the highlights of the PPP loans (and part of what made the demand for them so high) was that, if spent on qualified expenses, the loans will be forgiven. The process through which PPP loans were applied for, approved, and distributed was convoluted, inconsistent, and frustrating for many small business owners. Unfortunately, we have no reason to expect that determining exactly what portion of these loans will be forgiven will be any different. As was the case with determining who was eligible for a PPP and how big of a loan they were eligible for, we expect the IRS and the SBA to continue releasing changes and clarifications to the existing rules over the coming weeks and months.
That said, if you are of one of the companies that was fortunate enough to obtain a PPP from the first batch of funding (which was exhausted last week), you don’t have the luxury of waiting for further guidance. The PPP provides businesses with eight weeks to spend their PPP funds on qualified expenses or risk missing out on forgiveness, and if you’ve already received your funds then your eight-week clock has already started ticking.
Instead of saying “eight weeks starting when you receive your PPP funds” over and over, we’re going to refer to this as the “Forgiveness Period” for the rest of this article.
Haven’t applied for a PPP or unsure as to what we’re talking about? We discussed this and other aspects of the stimulus plan that businesses can take advantage of in our article Three Things Small Business Owners Should Do Today to Take Advantage of the CARES Act.
What does it mean that a portion of the PPP loan is forgivable?
As it currently stands, any portion of the PPP funds used for one of the following qualified expenses will be forgiven, i.e. will not be required to be paid back. In other words, if you spend the money the way they want it spent, it stops being a loan and becomes a grant. On top of that, whereas having a debt you owe be forgiven normally means you have taxable income, Congress has expressed their intent that the forgiveness of a PPP loan will not be taxable income to the company (as a side note, there is some confusion on this with regards to whether the expenses paid with the tax-free income will be deductible, and while it seems that this was Congress’s intent, the law may require some clarification to make this a reality).
Qualified expenses for the purposes of determining the forgiveness of a PPP include:
- Mortgage interest
How is the forgivable portion of the PPP loan calculated?
At the highest level, the forgiveness is calculated as:
Forgivable Portion = Spending During the Forgiveness Period on Payroll + Rent + Utilities + Mortgage Interest
Basically, qualified expenses paid during the Forgiveness Period are totaled up and that amount is forgiven. Just kidding, that amount is then subjected to limitations, phase-outs, phase-ins, and calculations to determine the actual forgivable portion of the loan.
The 75% payroll limitation
This is probably the most well-publicized limitation that factors into the forgiveness calculation. It requires that a company spends at least 75% of its PPP loan on payroll costs. If a company spends less than 75% of its PPP loan on payroll costs, the maximum amount that can be forgiven is decreased. The forgivable portion can be calculated as:
Forgivable Portion = Payroll Costs / 75%
- ABC Co receives PPP funds of $100
- ABC Co spends $50 on payroll costs, $40 on rent, and $10 on utilities
- The maximum forgiveness is $50 / 75% = $66
Another way to think about this is that the maximum forgiveness was decreased pro-rata based on the payroll costs as a % of the total PPP loan compared to 75%. In our example, the payroll costs were 50% of the total PPP loans. 50% is 2/3 of 75%, and our max forgiveness of $66 is 2/3 of the total PPP loan, which was $100.
The headcount reduction limitation
If a company reduces its headcount during the Forgiveness Period, the forgivable portion will be reduced based on the following calculation:
Forgivable Portion = Forgivable Portion after 75% limitation x
(# FTEEs in Forgiveness Period / # FTEEs in Base Period)
FTEE = full-time equivalent employees
Base Period = your choice of:
- February 15, 2019 to June 30, 2019
- January 1, 2020 to February 29, 2020
- An additional option for seasonal employers (as determined by the SBA) that is not worth getting into in this article
Basically, you compare your headcount in the Forgiveness Period to your headcount in your chosen base period, and if it has gone down you decrease your forgivable portion in the same ratio. Determining the # of FTEEs can get complicated, so if you’re ready to do this calculation, give us a call and we can help you with this analysis.
The headcount reduction safe harbor (this one helps you!)
The rules provide a way to avoid having your forgivable portion decreased because of headcount reduction, and it actually makes sense. In short, bring your headcount back up.
In long, if you decreased your headcount between February 15, 2020 and April 26, 2020 but you bring it back up to the original number (that it was on February 15th) by June 30, 2020, you can skip the headcount reduction limitation completely.
The salary and wage reduction limitation
Just like the law does not want to reward companies with forgiveness if they decrease their headcount, it also does not want to reward companies that decrease their employees’ wages or salaries by more than 25%. If a company decreases an employee’s wages during the Forgiveness Period by more than 25% as compared to the most recent full quarter of employment for that employee, the forgivable portion is decreased, dollar-for-dollar, by the decrease to the employee’s wages that exceed 25%. For example:
- ABC Co paid Alex $20,000 in Q1 of 2020
- ABC Co gets a PPP on May 1st, 2020 (let’s pretend there is still funding available) and, after previous limitations, its maximum forgivable portion is $50,000
- ABC Co cuts Alex’s salary to $12,000 in May of 2020
- 25% of Alex’s Q1 salary is $5,000, and Alex’s salary was cut by $8,000. The decrease in excess of 25% is $3,000.
- ABC Co’s forgivable portion is decreased by $3,000 from $50,000 to $47,000
This calculation must be done for every employee. Just kidding, that would be too simple. This calculation only applies to employees who did not receive wages or salary in any single pay period in 2019 that, when annualized, exceed $100,000. This means that if Alex earned $101,000 in 2019 their salary reduction would not have any effect on ABC Co’s PPP forgiveness (even if their salary was cut from $101,000 to $30,000).
It also means that if another of ABC Co’s employees, Pat, earned $40,000 in 2019, but included in that $40,000 is a bonus of $5,000, that bonus has to be annualized as if Pat earned that much for every single pay period. If ABC Co pays its employees twice per month that would put Pat’s annualized salary at $120,000 ($5,000 in a single period x 24 pay periods) and would let the company exclude them from the above limitation (despite their actual 2019 earnings being $40,000, which is well below $100,000). Don’t ask me how this makes sense.
The salary and wage reduction safe harbor (this helps too!)
If you’re following along at home, you probably see where this is going. Companies can avoid the salary and wage reduction limitation by restoring any salary or wages reduced between February 15, 2020 and April 26, 2020 to its February 15th level by June 30, 2020.
There is clearly a lot to digest here, and if you’ve made it this far, thanks for sticking it out! The rules surrounding the forgiveness of a PPP loan are confusing at best and incomprehensibly convoluted at worst, but we’re here to follow and dissect them for you so that you are able to make the decisions needed to manage your business through this crisis. If you’ve already received your PPP funds, now is the time to talk to us to ensure that the way that you spend and account for your PPP funds aligns with your company’s strategy for having the debt forgiven. If you’ve applied for or have been approved for a PPP, give us a call to discuss what you can be doing now to make sure you are well situated to utilize your PPP funds in a way that makes sense for your business.
This is a complicated and constantly changing area. Before taking any action you should always consult your tax advisor.