On March 27, 2020, the CARES Act became law, creating and allocating $349 billion to the new “Paycheck Protection Program” (“PPP”) administered by the Small Business Association (“SBA”). The PPP allowed small businesses and sole proprietors to apply for loans beginning April 3, 2020, while independent contractors and self-employed individuals could apply for loans beginning April 10, 2020. As of April 13, 2020, the SBA issued more than 1 million loans with more than 4,500 lenders under the PPP. Although the PPP was scheduled to remain open through June 30, 2020, on April 15, 2020, the SBA announced it had distributed all of the funds allocated for the program. This means that hundreds of billions of dollars are now in the hands of businesses throughout the U.S., who may not understand how to use the funds in such a way as to maximize the potential for loan forgiveness under the PPP.

Below, we will answer common questions regarding the PPP to assist businesses and their accountants. However, due to the rush to pass the CARES Act to provide relief to businesses and individuals, the law is not perfect – it contains contradictions and omissions. On April 15, 2020, the SBA published its “Interim Final Rule” containing some details and guidance regarding how the PPP will be carried out. More guidance will likely come in the coming weeks to clarify some remaining questions.

What if I did not submit an application or receive approval before the SBA ran out of funds? The SBA and U.S. Treasury have requested that Congress appropriate additional funds to the PPP to continue supporting businesses in keeping citizens employed. It is possible Congress may appropriate more funds, so businesses should be ready with their loan applications in the event the opportunity arises. In the meantime, other forms of relief are available. For example, the SBA’s debt relief programs are available, offering payment of the principal, interest, and fees for up to 6 months on certain loan types or, in other cases, deferring loan payments on SBA disaster loans through December 31, 2020. Some state and local governments have issued similar forms of low-cost loans, while specific lenders may defer or extend debt obligations on a case-by-case basis.

Our firm is available to assist businesses with negotiating deferments or restructuring of debt, or in worse cases, advising and navigating through bankruptcy filings.

How do I obtain forgiveness of my PPP loan? The PPP loan may be forgiven in whole or in part, if and to the extent that certain requirements are met: (1) the loan proceeds must be used for payroll costs and other specified uses, (2) the proceeds must be used (spent) within the allowed time frame, and (3) not more than 25% of the loan forgiveness amount may be attributable to non-payroll costs. The purpose is to provide eight weeks of payroll costs and keep businesses operating.

Forgiveness may also be limited to the extent an employer does not maintain its staff and payroll.  One possible reduction is based on comparing (i) the average number of full-time employees employed during the 8-week period following the PPP loan, with (ii) the average number of full-time employees employed during either: (a) February 15 through June 30, 2019, or (b) January 1 through February 29, 2020. A second possible reduction occurs when the total salary or wages of an employee is reduced by more than 25% of the amount during the most recent quarter during which the employee was employed before the employer received the PPP loan. However, an employer can cure any potential reduction by bringing its staff and payroll back to pre-February 15, 2020 levels by no later than June 30, 2020.

After the 8-week period ends, an employer should contact its lender and provide evidence that it qualifies for forgiveness. The CARES Act explains that the employer seeking forgiveness shall complete an application and provide documentation of the following: (i) the number of full-time employees on payroll and pay rates for all relevant periods, payroll tax returns filed with the IRS, and state income, payroll, and unemployment insurance returns; (ii) cancelled checks, receipts, account statements, and other documents verifying payments on covered mortgage obligations, lease obligations, and utility payments; and (iii) a certification that the documentation is true and correct, stating the amount of forgiveness being requested and payments of each covered expense.  The PPP lender must make a decision on loan forgiveness within 60 days, which amounts will thereafter be paid by the SBA directly to the lender. It is likely that the SBA will provide more guidance on how to request forgiveness in the coming weeks.

What payroll costs can I pay with the loan proceeds to maximize forgiveness? At least 75% of the loan proceeds should be spent on payroll costs, including the following categories:

  • Salary, wages, commissions, or tips, but only in such amount that would not exceed $100,000 on an annualized basis per employee;
  • Employee benefits, including costs for vacation, parental, family, medical, or sick leave, separation or termination pay, the cost of group health care benefits including insurance premiums, and retirement benefit premiums;
  • State and local taxes assessed on the compensation; and
  • For an applicant who is a sole proprietor or independent contractor, the wages, commissions, income, or net earnings from self-employment, capped at $100,000 on an annualized basis per person.

What payroll costs may not be paid with loan proceeds?

  • Compensation to employees whose principal residence is outside of the U.S.;
  • Compensation to any employee in excess of an annual salary or $100,000, as prorated;
  • Federal employment taxes imposed or withheld between February 15 and June 30, 2020, including both the employee’s and the employer’s share of FICA, Railroad Retirement Act taxes, and income taxes withheld from an employee’s wages;
  • Wages paid for qualified sick and family leave for which a credit is allowed under the Families First Coronavirus Response Act; and
  • For business PPP loans, amounts paid to independent contractors, who are not considered “employees” for purposes of loan forgiveness since they may apply for a PPP loan on their own.

What other expenses can I pay with the loan proceeds to maximize forgiveness? Up to 25% of the loan proceeds may be used to pay the following business expenses:

  • Rent, provided that the lease agreement was in force before February 15, 2020;
  • Utilities, provided service began before February 15, 2020; and
  • Mortgage interest, provided the mortgage was incurred before February 15, 2020.

According to the CARES Act, the loan proceeds may also be used to pay interest on any other debt obligation incurred before February 15, 2020. However, the language of the Act excludes these payments from qualifying for loan forgiveness.

What if an employee’s Form W-4 requests additional tax withholdings? When an employee’s spouse is an independent contractor or sole proprietor who does not receive wages subject to withholding, the employee may have a Form W-4 on file requesting additional tax withholdings. While the federal employment taxes deducted from the employee’s wages would not qualify for PPP or corresponding loan forgiveness, the portion of additional state and local taxes might. Although the SBA has issued no specific guidance on this issue, general guidance suggests that the additional state and local taxes will be covered under the PPP forgiveness scheme. However, it is possible that the SBA and/or institutional lenders may revise their forgiveness eligibility before the time in which a business may request forgiveness. An employer faced with this problem can argue that it was required to follow the employee’s Form W-4 in making the additional withholdings, and the argument is bolstered if the Form W-4 was on file prior to 2019 (the eligibility period on which the loan amount was based). However, like the “novel” coronavirus, both lenders and borrowers are in uncharted territory, where anything is possible.

Moreover, if an employer wants to maximize its “payroll” subject to forgiveness, it can request that employees complete new Form W-4s to minimize the unforgivable federal taxes and maximize the forgivable “wages” portion of each payroll check. Alternately, employers could increase employee wage rates or issue commissions or bonuses during the 8-week period to maximize the “payroll” expended during the covered period.

What if the employee’s paycheck is subject to other non-tax deductions? No specific guidance has been issued on this point. However, based on the guidance issued to date, most deductions (other than federal taxes) may be applied to PPP loan proceeds subject to forgiveness. Some employees may have their paychecks reduced by such deductions as child support, transportation benefits, or union dues. For items that are generally considered “employee benefits” such as pre-tax transportation deductions, the amount of benefit should be covered by the PPP and corresponding loan forgiveness. For other post-tax deductions such as child support or union dues, these will likely also be covered because they first qualify as “wages” before the deductions are made. However, as mentioned above, the SBA may publish additional guidance, or lenders may impose discretionary policies, providing for a different result.

How long does the business have to spend the loan funds? The CARES Act provides that the loan proceeds may be used for qualifying expenses during “the covered period,” which is defined as “the period beginning on February 15, 2020 and ending on June 30, 2020.” However, for purposes of loan forgiveness, the term “covered period” means “the 8-week period beginning on the date of the origination of the loan.” Current SBA guidance has limited the potential loan forgiveness to those qualified payments made “during the eight week period after loan disbursement.” Thus, although a business may use the funds to pay for costs incurred back to February 15th, that portion will not be subject to loan forgiveness.

For example, if a business submitted its application on April 4th, spoke with a loan broker over the phone and received loan approval on April 14, signed the loan documents on April 15, and received confirmation that the loan was approved on April 16th, can the business apply payroll made on April 15th to the loan proceeds from which it seeks forgiveness? Probably not. Although the April 15th payroll may be paid with loan proceeds because it was incurred within the “covered period” for the PPP (i.e., 2/15 – 6/30), it was paid before the loan disbursement and applied to wages earned before the covered period, and thus would not be subject to forgiveness.

Should the covered expenses be calculated on a cash or accrual basis? The CARES Act states only that forgiveness will be made for “costs incurred and payments made during the covered period.” Unfortunately, there is no guidance as to how the expenses should be calculated for purposes of forgiveness. One interpretation would be to view “costs incurred” as accrual-based expenses and “payments made” as cash-based expenses. This interpretation would be broad enough to encompass a greater amount of expense and be flexible enough to cover differing account systems. For example, if the PPP loan was disbursed on April 15th, it would apply to payroll made on April 20th, because the checks were cut on that date, even though wages were earned prior to April 15th. At the end of the 8-week period on June 10th, it could be argued that wages accrued through June 10th could qualify for loan forgiveness, even though they were not paid until after the covered period ended.

A different interpretation would be to interpret the “and” to require the cost to be both “incurred” and “payment made” before it would be subject to forgiveness. This interpretation would vastly limit forgivable expenses. For example, if the PPP loan was disbursed on April 15th, would it apply to payroll made on April 20th? Although the payroll checks were cut on April 20th (i.e. “payment made”), most of the wages were earned before the loan disbursement date. Under this interpretation, it is not clear whether all, none, or some portion of the payroll would be subject to forgiveness for meeting the requirements. Because of the potential uncertainty and harsh result of this interpretation, it is unlikely the interpretation would be enforced. Nevertheless, it is clear that more guidance from the SBA is needed to help businesses understand what expenses will be “forgivable.”

What recordkeeping is required? To obtain loan forgiveness, the borrower must document how the proceeds were used and show that at least 75% of the requested forgiveness was used for payroll costs. The employer must provide documentation of the number of full-time equivalent employees on payroll as well as the amounts for both the 8-week “covered period” and the various “lookback periods” (see above). Forgiveness will only be provided for documented payroll costs and covered mortgage interest payments, rent payments, and utilities. While current guidance explains that a lender does not need to verify the borrower’s documentation submitted to obtain loan forgiveness, the CARES Act provides that no employer will receive forgiveness without providing all required and requested documentation verifying the employer’s right to forgiveness.

This poses a question of how an employer should maintain its records to maximize the likelihood of loan forgiveness. Given that most bookkeeping software will not automatically calculate the portions of expense that qualify for forgiveness (i.e., removing only the portion of federal taxes withheld from paychecks while keeping all other deductions), employers may need to keep manual calculations of qualified expenses. On the other hand, it is not clear what a lender would do in considering whether to grant forgiveness where an employer provides only gross payroll figures and payroll tax returns. Hopefully the SBA will issue additional guidance to assist employers in maintaining records and requesting forgiveness from lenders.

Does the PPP loan forgiveness create taxable income under Internal Revenue Code Section 61(a)(11)? No. The CARES Act provides that forgiveness of a PPP loan is tax-free and should be excluded from gross income.

What happens if I am not entitled to 100% loan forgiveness? To the extent a PPP loan is not or cannot be forgiven, it will be treated as a standard loan. Interest will accrue at 1%, and the loan will mature (i.e., must be paid) two years from issuance. Payments are deferred for the first six months, although interest will accrue during this period. Since there are no prepayment penalties, any loaned amounts not subject to forgiveness can be repaid at any time.

Are there any consequences for misuse of PPP loan funds? Any loan funds used for unauthorized purposes will not be forgiven and must, therefore, be repaid. Anyone who knowingly uses PPP funds for unauthorized purposes, including individual shareholders, members, or partners, may be subject to civil or criminal liability, such as charges for fraud. Persons who falsely certify PPP loan applications may be subject to significant fines and even imprisonment.

Conclusions. Because of the confusion and uncertainty regarding how to calculate expenses for purposes of loan forgiveness, we are hopeful that the SBA will issue new guidance to assist businesses and lenders in determining how to calculate forgivable expenses. However, under the current guidance in the CARES Act, a PPP borrower can be “eligible” for loan forgiveness, but ultimately the decision is at the discretion of the lender. Nonetheless, because the Act requires the SBA to reimburse the lender once it grants loan forgiveness (or alternately purchase the loan from the lender), and because the Act holds the lender harmless for relying on documentation submitted by an employer to support its application for loan forgiveness, a lender has little incentive to deny forgiveness.

Therefore, an employer who has already received PPP loan proceeds should carefully document all possible payroll and other covered expenses and submit them to the lender upon the conclusion of the 8-week period with the employer’s application for loan forgiveness. Even if a lender partially denies an application for forgiveness, the employer will still benefit by receiving substantially “free” funds to keep its employees employed and its business running, while receiving a low-cost loan for any unforgiven amount that can be repaid at any time without penalty.

During the next 8 weeks, employers who received PPP loans should watch for additional guidance by the U.S. Treasury and SBA and update their expense payments and record-keeping to conform with any policy changes.


Sandra Mertens
[email protected]